With Small Business Administration loans fetching less on the secondary market than they once did, Unity Bancorp Inc. in Clinton, N.J., has decided that retaining the loans is a better strategy these days than selling them.
The change will reduce profits at first but boost them in the long run, said James A. Hughes, Unity's president and chief executive.
Other large SBA lenders might reach the same conclusion, unless rates that investors are willing to pay for the loans go up, industry observers said.
The $732 million-asset Unity has been one of the most active SBA lenders among community banking companies in recent years, and it intends to become an even bigger player by opening loan production offices throughout the eastern United States.
Like many large SBA lenders, Unity had been selling the government-guaranteed portion of the loans in the secondary market and retaining the rest. In the second quarter its $824,000 gain on the sale of SBA loans accounted for more than half of its $1.5 million profit.
Still, Mr. Hughes said, investors are paying less for the loans than they were 18 months ago.
A few years ago most of Unity's SBA loans were variable-rate, with spreads as wide as prime plus 2.5%.
More recently Unity had to offer fixed rates at lower spreads to stay competitive. Spreads now range from prime plus 1.25% to prime plus 2%, Mr. Hughes said.
Because the loans are less profitable, the secondary market is bidding accordingly, he said. "We've noticed that the bids have become increasingly weaker over the last year and a half. It's not something that happened overnight."
At the lower rates it would take 12 to 14 months for Unity to earn the amount it could have received if it had sold the loans, Mr. Hughes said. Previously the company would have had to hold the loan for 20 months before it earned the amount of money it could get from a sale, he said. "You ask yourself: 'Why am I going to sell it, if I could get that entire gain back within a year, and after that it's all additional spread income?' "
Unity is not keeping all its SBA loans. It will evaluate each loan individually, Mr. Hughes said.
The company has not reported third-quarter earnings but warned that its gain from the sale of loans would be about half that of the second quarter.
Paul Merski, the chief economist for the Independent Community Bankers of America, said investors are eager to snap up the government-guaranteed portion of each SBA loan, because "it is an attractive product."
But Mr. Merski agreed that more lenders might reconsider selling the loans at current rates.
"The return that banks can get on these loans in the secondary market has gone down," he said. "The economics of it could be that it makes sense for them to hold more of these loans on their books."
Last year Unity made 166 SBA 7(a) loans worth $65 million. Through the first eight months of this year it had made 82 loans worth $42 million.
According to SBA data, Unity was the 34th-largest 7(a) lender by dollar volume in the federal government's fiscal year that ended Sept. 30, 2006, and No. 51 by number of loans. (Fiscal 2007 data is expected to be released this month.)
Mr. Hughes said Unity is trying to boost its SBA volume with an aggressive growth effort that focuses on key markets east of the Mississippi River. This year it opened three loan production offices in Florida and one in North Carolina to begin doing small-business lending in those states.
It also has hired a lender in Chicago and one in a Virginia suburb of Washington, bringing its SBA team to an all-time high of 11 members, Mr. Hughes said.
Unity is looking to hire in New England and possibly other markets. But it is flexible about where else it might go, Mr. Hughes said. "When you find the right person, you build a market around them."
Unity has long had a loan production office on Long Island, New York, he said, "so we weren't just a New Jersey SBA lender before. But now we're making a conscious effort to grow."
SBA loans make up about a third of Unity's lending volume. The company would like to keep the ratio at or above that level, Mr. Hughes said.
"As the core bank is getting larger, the SBA as a piece of that bank has been getting smaller," he said. "And the SBA has really been one of our most profitable departments, so we want to keep that department proportionally as large as the bank."
No analysts follow Unity, but Matthew Schultheis, an analyst at Ferris, Baker Watts Inc. in Baltimore, said he is familiar with the company.
He said SBA lending is competitive nationwide, so targeting that niche can be tough. "This is a pretty crowded market. There are a lot of companies doing this that aren't even banks."
Nonetheless, Unity might have an advantage over some of its rivals, Mr. Schultheis said.
Even though larger banking companies might offer loans to small businesses, they tend to emphasize middle-market borrowers more, because that can generate more volume with fewer loans, he said.
Unity's targeted approach has the potential to capture more small-business customers, Mr. Schultheis said. "I think they do very well in the SBA space because they're so focused on it," he said. "They're not a monoline, but they're pretty close to it."
Mr. Hughes said Unity had commercial loan growth of more than 15% in 2006 and is on track to achieve that again this year.
He said Unity's expertise in SBA lending made that a logical focus for the 16-year-old company's growth effort. "We've been a preferred SBA lender almost since the inception of the bank," he said.
Unity is also trying to improve in retail, with plans to add one to three branches a year and step up its residential lending. "We'd like to be a large residential lender as well," Mr. Hughes said.
Unity hired Mark Sovelove as a senior vice president last year to oversee its mortgage division, and it overhauled that department. It wants to take advantage of the market disruption to add lenders and possibly acquire a mortgage company, Mr. Hughes said.
"Eventually the market will turn around and people will start buying homes again," he said. "We'd like to have the infrastructure in place when that happens."
All of Unity's 16 branches are in New Jersey and Pennsylvania, including one that opened in Lehigh Valley in August. Mr. Hughes said the new ones are being planned for counties in its market with the strongest population growth: Hunterdon and Warren in New Jersey and Northampton in Pennsylvania.
The company also might divest branches it believes are not in good markets, Mr. Hughes said.
