Morgan Stanley (MS) plans to buy up to $500 million of commercial property loans made to small businesses over the next few years, a move the bank says should help ease credit by allowing community and regional banks that make such loans to move them off their books and make new ones.
The investment will inject much-needed liquidity into a loan market that has not yet recovered from the financial crisis. Morgan Stanley will buy commercial mortgages made through the Small Business Administration's 504 program, which companies can use to purchase or improve their properties or invest in new equipment. 504 loans, which are partially guaranteed by the government, require businesses to create or retain one job for each $65,000 that the SBA guarantees.
Small banks may be more willing to lend to businesses knowing Morgan Stanley is ready on the other end of the transaction to buy their loans, says Mike Mantle, a senior adviser in the investment bank's global sustainable finance group. "These loans have historically not been the types of assets that community and regional banks wanted to park on their balance sheets," Mantle says in a phone interview. "To the extent that they have an option to sell them, that gives them the flexibility to increase their lending activity." Morgan Stanley has already purchased loans from two lenders and will commit the money over the next few years, Mantle says, though he declined to specify a time frame. (Morgan Stanley's commitment will contribute to its score under the Community Reinvestment Act, which rates bank holding companies on their lending in underserved communities. Officials from the bank say the program was not designed to meet CRA requirements and is one of many activities that contribute to Morgan Stanley's rating.)
Small lenders that make 504 loans often depend on reselling those loans to investors to get the cash needed to make new loans. Most private buyers for 504 loans dropped out after the financial crisis, says Jim Hammersley, head of the SBA's policy office. "That market simply disappeared during the credit squeeze and it has not come back," he says. Lending under the 504 program dipped by more than a quarter to $8.5 billion in the year following the financial crisis, according to SBA data. It recovered somewhat in 2010, with $9.75 billion originated in 7,833 loans during the 12 months ended Sept. 30. Morgan Stanley's commitment is worth more than 5 percent of all the 504 loans made last year.
In a 504 development project, the small business typically puts down 10 percent of the cost, and takes out two loans to finance the rest. One portion, for 40 percent, comes from a nonprofit known as a Certified Development Company and is guaranteed by the SBA. The other 50 percent comes from a commercial lender, often a community or regional bank, that has the first claim against the property if the borrower defaults. Unlike other investors, including Bank of America Merrill Lynch (BAC), which buy pools of 504 loans packaged into securities, Morgan Stanley plans to buy whole commercial loans, known as first lien mortgages.
The number of institutions willing to buy such loans has dwindled since the financial crisis from about six companies, including Lehman Brothers and GE Capital (GE), to just one remaining buyer, Zions Bank (ZION), says Jordan Blanchard, executive vice-president and manager at CDC Direct Capital, which pairs loan sellers with buyers and is partnering with Morgan Stanley. Zions, which cut back on its purchases, "made a concerted effort to stay in the market," says Paul Herman, small business lending manager at Zions subsidiary California Bank & Trust.
More Competitive Rates
Small lenders also find it harder to compete with larger banks that have lower costs of funds, he says. Blanchard says community banks might have had to offer such loans at 6 percent where larger lenders could offer 4 percent. "The small banks have not had a tool to compete against the big banks," he says. Morgan Stanley's backing will allow them to offer businesses loans at more competitive rates, Blanchard says. The bank is also offering an option for 25-year fixed-rate loans, a longer fixed-rate term than most community banks are able to offer on their own, says Blanchard.
Last year the SBA extended a guarantee to such loan pools sold on the secondary market, and $92 million worth of loans has been resold to investors since September, according to SBA data. Congress has made several other changes to the 504 program to make it more attractive to borrowers by increasing the size of businesses that qualify and offering larger loan guarantees of up to $5 million or, for manufacturers, $10 million.
The SBA expects demand for the 504 program to increase significantly this month because for the first time companies will be able to use it to refinance existing commercial mortgages, the SBA's Hammersley says. The refinancing program, targeted at borrowers who are current on their existing property loans, will let them refinance at more attractive rates. The SBA is preparing for a flood of refinancings under the program, he says.
Refinancing will let businesses take advantage of historic low rates, says Frank Altman, chief executive officer of Community Reinvestment Fund, a nonprofit working with Morgan Stanley to channel capital to 504 lenders. "If a business is capable of borrowing, this is a great time to be borrowing for fixed assets," says Altman. He predicts the investment bank's $500 million will make it easier for banks to make new loans. "What the business lending market needs on a number of fronts is liquidity," Altman says. "This approach Morgan Stanley is taking will move that liquidity into community banks and others."