Managing Commercial Real Estate Interest Rate Risk with the SBA

We are in a current environment where interest rates have dropped substantially over the past year.  The 5-year US Treasury sat at 2.72% a year ago and is now at 1.43%.  The 10-year was at 2.82% a year ago and is now at 1.84%.  Yesterday, the yield curve remained inverted with the one-month T-Bill ending at 2.09%, while the 30-year T-Note ended at 2.04%. 

Inverted yield curves have been a signal to a recession.  Usually the recession comes 12-18 months after the yield curve inverts.  But in each case of rate yield curve inversions in the past, it is started with the Federal increasing the short end of the interest rates beyond the longer end.  Zach’s Investment Management cites that the low long-term yields prevailing in the current markets are partially attributable to special factors.  The Federal Reserve still is holding many long-term treasuries they accumulated through its past quantitative easing policy.  The United States is also viewed as a safe haven to invest in as we have one of the few industrialized economies which continues to grow.  Also, there is nearly one trillion dollars of sovereign debt which now is at negative interest rates.  Investors will put money in the U.S. with a positive yield and growing economy compared to some other countries with a negative yield and contracting economy.

This slight inversion, or really a flattening, of the yield curve is flashing a recession signal is yet to be seen.  But the important point I want to chat about is that your borrowers also know that the interest rates are lower.  Some of the current market rates are substantially lower today than the current interest rate on their loan.  As such, you may be experiencing requests to refinance their loan to take advantage of the current low interest rate.  As a lender, you may not be thrilled in giving up an asset that is earning interest at a higher interest rate for one that may be a point or two lower, or maybe even more!  But if you don’t bite on their request, the local banker down the street will be very accommodating to this request from a good borrower.  If you let the borrower go (and some borrowers, you will celebrate when they leave) you must replace that earning asset with ones at a lower market rate. 

One option may be to consider using the SBA 504 program to help refinance the loan on owner-occupied real estate.  Now this cannot be used to shift risk of a problem loan to the SBA.  It may be a tool that you can off-load some of the commercial real estate debt to a fixed interest rate loan of up to 25 years, and still keep a smaller first mortgage and continue to keep the relationship. 

The current interest rate for a 20-year 504 SBA loan for this month was 3.53%.  The 25-year rate is at 3.63%.  These are incredibly low fixed interest rate for borrowers.  The 504 loan is in a second mortgage position behind your first mortgage.  You still have flexibility to offer a fixed or adjustable interest rate on your first, you just have to have at least a ten-year term on your loan and an amortization that produces a repayment which is at the same rate or slower than the 504 loan.  These low interest rates are creating an increase of 25% nationally in 504 applications compared to the previous year. 

The 504 option may help you refinance some desirable commercial loan relationships that are currently held at other institutions.  It may also help get new business projects.  The typical 504 loan structure has a lender first mortgage at 50% of the project and an SBA 504 second between 30-40% with the borrower putting in 10-20%.  There are other requirements and you should check with us or with your local Community Development Corporation working with 504 loans for information on your specific project.