Rural areas rely heavily on community banks as their lifeline to mainstream financial services. The FDIC reports that there are more than 1,200 counties (a third of all U.S. counties) where community banks are the only option. If you are one of these “lifeline” lenders serving a rural area, then you will want to know more about this loan program.
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In a previous article, we looked at under-utilized USDA loan programs. Let’s look more closely at one in particular, Community Facilities. Not only does it provide critical benefits for growing and/or revitalizing rural communities, but it offers lenders financial benefits that many haven’t considered.
What it Means for Borrowers and Communities
The Community Facilities program is designed to help build “essential community facilities” in cities or towns of less than 20,000 residents. An essential community facility means that it improves or develops the community, but doesn't include private, commercial, or business undertakings. Examples of projects that VITAL has been involved with include healthcare facilities, assisted living centers, education institutions, hydroelectric facilities and industrial parks. Eligible borrowers are public entities, community not-for-profits, and federally recognized tribes.
Borrowers in rural markets encounter extra challenges when they seek financing. Though every community lender I’ve worked with is eager to serve the needs of the local area, loan requests for rural communities can be difficult for lenders to undertake for many reasons, including the size of the project, the specialized nature or complexity of the project, or the extended terms requested by the borrower. In addition, some of the projects may be eligible for tax-exempt general obligation or revenue bonds, and local lenders may feel they cannot compete for such a project. Without access to funding for important community projects, rural communities can struggle to maintain a desired level of quality of life for residents.
The USDA Community Facilities loan guarantee program can be of tremendous assistance by increasing banks’ lending limits, providing risk mitigation for specialized facilities with low or no marketability, and allowing for extended terms on loans. In some instances, the USDA will have money available for direct loans, which can be paired with a bank loan to lower the overall interest cost to the borrower.
Benefits for Lenders
Loans backed by the Community Facilities program receive guarantees of 90% of the loan amount. This offers high leverage to banks who want to sell on the secondary market; the originating lender keeps 10% of the loan and sells the remaining guaranteed portion.
Depending on how the loan is priced and structured, the premium can range from 5% to 10% of the sold portion of the loan. When the interest is added to the loan sale premium, the lender’s return on their loan asset can be as high as 100%. When the guaranteed portion of the loan is sold and returned to the lender, it can be reused for additional loans, further increasing the return the lender receives. All banks, regardless of loan-to-deposit ratio, can benefit from this feature, but banks with high loan-to-deposit ratios particularly benefit, as they can make sizable loans with long terms and still have money for continued lending.
The financial benefits for lenders can be quantified on the income statement – but many find the reputational benefits to be just as valuable. In my experience, banks that successfully use the Community Facilities program become the local community hero. Important community projects can languish or die without a funding resource, so being an instrumental force in turning them into reality is something really meaningful. This raises the bank’s regard, and helps it become a place that both businesses and residents increasingly turn for their financial needs. I have yet to meet a community banker that doesn’t have that on his or her short-list.