The Cost of Doing Business in SBA Lending
I’ve always wondered why in banking no one ever talks about the cost of operating a line of business. We discuss credit decisions to great lengths, along with loan policies, compliance, IT security, etc. But no one really talks about the cost of doing business and what the bank ultimately needs to do to make money. So let’s talk about it.
Any business, banks especially, have overhead such as facilities, equipment, furniture, insurance, IT software, and security. These are fixed or semi fixed costs, whether your bank has an SBA department or not. So if you’re going to add an SBA department, the added costs are mostly personnel, which would be an SBA Business Development Officer (BDO), an SBA underwriter, experienced SBA processor and someone who can handle post close SBA loan servicing. Depending on the geographic location, the cost of adding said personnel will vary greatly. I can tell you from experience that a capable BDO will cost around $120k annually, plus commission, an underwriter is about $120k annually, and an experienced processor is generally paid around $70k annually. We will leave servicing out of this discussion for now. So your core SBA staff costs are roughly around $310,000 annually.
Now let’s talk about revenue. Let’s say your SBA BDO generates $10,000,000 in SBA loans in a year and the bank sells the 75% SBA guarantee on all those loans. With $10,000,000 in loan production, the bank can sell $7,500,000 guaranteed portion at an estimated premium of 10%, creating a $750,000 premium or gain. The bank also made interest income; let’s use Prime + 2.0% or 10.5% today. I am assuming the bank made these loans throughout the year, so the bank will end the year with $2,500,000 in unguaranteed pieces of SBA loans. Since the loans are funded evenly over the year, the average loan balance for purposes of calculating interest and servicing income, is half of the unguaranteed balance or $1,250,000. That number multiplied by 10.5% equals $131,250. Let’s assume a cost of funds of 4.0% or $50,000, so the net interest income is $131,250 - $50,000 = $81,250. The bank also made Servicing income of 1.0% on the amount sold (averaged for the year); $375,000 X 1.0% = $37,500. So the total income for the bank is as follows:
SBA Income
Loan premiums $750,000
Net interest income $ 81,250
Servicing income $ 37,500
Total Income $868,750
SBA Expenses
Staff cost $310,000
BDO Commission $100,000 (Assumes 1.0% commission)
Loan loss provision $ 5,000 (Assumes 2.0% on $2,500,000 unguaranteed portion)
Total Expense $415,000
Total Net Income $453,000
Now what happens to this model if your BDO only produces $5,000,000? There are some key considerations that need to be factored into this discussion. One factor to consider is the percentage cost (%) to the bank to generate $10,000,000 in SBA production. That is calculated as follows, ($415,000 expense / $10,000,000) = a 4.15% cost for production. Part of this is amortized over the life of the loan, per the accounting requirements, but for our purposes it is good to know that number. What do these numbers look like with a production drop of 50%? The income side will be cut in half, as are the commissions and provisions. That means income will be $434,375 and the expenses are $362,500, for a net profit of $71,875. This number is far less impactful for the bank. But look at what happens to your cost of production ($362,500/$5,000,000) = 7.25%. Most banks would look at the small profit that they made, but not consider the high percentage cost to generate that income. What happens if the BDO you hire doesn’t produce at all? That means not only have you lost money paying for a salesperson that didn’t produce, but also for a loan processor and underwriter.
When starting an SBA operation, there are many factors to consider, especially the cost of doing business. This is why the LSP model makes sense if your institution is interested in getting into the SBA business, but unsure of your production capability. A quality LSP vendor relationship allows you to create an SBA department on a variable cost basis, without the risk of committing to the staffing overhead. Under our variable cost model, it doesn’t cost the bank a penny to sign up and to have an exceptional SBA team at the ready for when you do have an SBA request. Under our variable cost pricing, a lender makes money if they do one loan (or twenty) and for a far lower cost than what I have outlined above. This also allows you time to learn best practices from us for when you have enough SBA activity to support your own internal operation.
Written by Brian Carlson