THE BLOG
10/07/2010 10:59 am ET | Updated May 25, 2011

New Refinancing Program May Help Stem a Pending Foreclosure Disaster

"Large Banks Creating Crisis For Hoteliers," according to the title of an article by Stanley Turkel, an author and hospitality industry consultant. The article notes that large banks benefited from the Troubled Asset Relief Program (TARP), and yet they will not restructure or extend commercial real estate loans to keep their borrowers in business.

"On the other hand," the article says, "small community banks are demonstrating a strong willingness to arrive at mutually acceptable workout arrangements with commercial borrowers like hotel owners." Turkel writes that the large banks "have no incentive to come to a mutually acceptable solution with the borrower."

Confirming the lousy borrowing environment, Anthony Downs says, "Many banks are restricting their lending on real estate because they already have so many nonperforming real estate loans on their books. He is a senior fellow at the Brookings Institute, and opined in the National Real Estate Investor. He said, rather than reaching out to help new customers, "These banks are focusing on longtime and large customers whose business they want to retain."

Looming largely under the radar, pundits say that $350 billion of commercial mortgage loans are coming due for payoff in 2011. Moreover the balloon balances still owed are so high that many borrowers will be unable to refinance conventionally. What's more, conventional lenders have tightened their underwriting standards, and borrowers who easily qualified when they originally borrowed the money are barred from refinancing. Moreover, many of these borrowers are small-business owners that occupy their own building, store, restaurant, hotel, motel, bowling establishment and a potpourri of other facilities that they will lose to foreclosure if they cannot come up with a wad of cash to repay their loans.

But there may be a white knight coming to the rescue for some small-business owners. HR 5297, the new "Small Business Jobs Bill," allows the U.S. Small Business Administration to use its 504 program to commence refinancing commercial properties when a small-business borrower has a balloon mortgage-note coming due. The program is meant to payoff existing loans with long-term, low fixed-rate mortgages.

During the real estate boom, easy credit allowed borrowers to highly leverage their commercial properties. The key underwriting ratios were more liberal back then.

Before the financial meltdown it was common to borrow 80 percent of value or higher to finance commercial real estate. But today, the same lenders want 65 to 70 percent of value.

The second important ratio is debt service coverage. It is calculated when you divide the cash flow available to pay debt service by the debt service. Prior to the credit crunch, a ratio of 1.15 was acceptable. Additionally, aggressive lenders would use projected income to make deals work. Some would even allow a 1.10 debt service coverage ratio when they wanted a deal badly enough.

Currently, a minimum of 1.25 or more is the standard and it is based on existing income -- not projections. If the cash flow from business operations used is, instead of income from tenants' leases, the debt service coverage ratio requirement is higher. Additionally, they scrutinize the applicant's operating expenses, check tax returns and compare them to industry data before accepting the business-owner's word for it.

The result is that borrowers are unable to pay off their existing loans when the balloons come due.

That is why SBA is now offering to refinance these loans with new mortgages at up to 90 percent of value. For single-purpose buildings, the percent of value may drop to 85. The loan may be increased to 125 percent of value by providing additional collateral.

I have estimated the maximum financing at approximately $11 million. It can go higher for manufacturers, certain energy-related companies, or if a lender is willing to take more risk. That is because lenders usually limit their first mortgage to 50 percent and SBA takes a 40-percent junior position in the form of a subordinated debenture. The combined interest rate is currently under five percent.

SBA's preliminary guidelines state that small-business owners must occupy at least 51 percent of the property and the existing loan has to be at least two years old. During the last 12-months, SBA requires prompt payments on the existing loan. The agency defines qualified small-business concerns as borrowers whose maximum tangible net worth does not exceed $15 million. Additionally, borrowers' two-year average net income after federal income tax has to be $5 million or less.

Proceeds from the new SBA loan must be used for eligible fixed assets, which include real estate, machinery, fixtures and equipment.

I've asked SBA for more definitive refinancing guidelines but have not heard back from them yet. It appears, however, that the usual job-creation requirement under the 504 program for new construction or acquisition will be waived. Moreover, most borrowers' transaction fees will temporarily be paid by the agency.

Notably, lenders are prohibited from refinancing existing loans made with guarantees from SBA or other federal agencies.

The 504 program is facilitated by SBA-licensed Certified Development Companies. You can find most of them at National Association of Development Companies' web site.

Jerry Chautin is a volunteer SCORE business counselor, business columnist and SBA's 2006 national "Journalist of the Year" award winner. He is a former entrepreneur, commercial mortgage banker, commercial real estate dealmaker and business lender.