• SBA Best Practices: Prudent Lending and SBA Collateral Policies on 7(a) Loans
  • July 19, 2017 | Authors: Jennifer Borra; Kristen G Dickey
  • Law Firms: Starfield & Smith, P.C. - Maitland Office; Starfield & Smith, P.C. - Fort Washington Office
  • As a follow up to last week's publication on SBA's collateral policies, this week's article is designed to clarify points raised, cover topics not addressed, and identify challenges which Lenders face.

    SBA places the onus on lenders to use "commercially reasonable and prudent practices to identify collateral items, which conform to procedures at least as thorough as those used for their similarly-sized non-SBA guaranteed commercial loans." Furthermore, when assessing the adequacy of collateral, the Agency requires lenders to consider both what to take as collateral and how to value the collateral.

    In the SOP 50 10 5 (I), page 155, SBA offers guidance on the collateral needed when loan proceeds are used to refinance existing debt (the loan must be secured with at least the same security and lien priority as the debt that is being refinanced). Furthermore, SBA explains that it considers a loan to be "fully-secured" if the lender has taken security interests in all available fixed assets with a combined "net book value" up to the loan amount. Guidance on valuation methods (i.e. advance rates) for machinery and equipment and real estate are provided. When shortfalls exist, the SBA furnishes lenders with a process to assist their determinations and, in a further effort to assist Lenders, SBA provides flexibility in the following circumstances.

    • The lender is not required to collateralize a loan with a lien on a personal residence or investment property to meet the "fully secured" definition when the real estate equity is less than 25% of the fair market value.
    • A lien on a personal residence or investment property MAY be limited to the amount of the collateral shortfall.
    • A lien on a personal residence or investment property MAY be limited to 150% of the equity in the collateral, rather than the loan amount, if there are tax implications associated with the lien amount in the particular state where the lien is filed.

    The SBA separates its collateral requirements into three (3) distinct categories: (1) loans of $25,000.00 or less, (2) loans over $25,000.00 but less than or equal to $350,000.00, and (3) loans over $350,000.00. The following summary identifies the differences between these categories.

    (1) Loans of $25,000.00 or less (excluding SBA Express and Export Express)

    • The lender is NOT REQUIRED TO TAKE COLLATERAL.
    • The lender MUST obtain personal guarantees.

    (2) Loans over $25,000.00, but less than or equal to $350,000.00 (excluding SBA Express and Export Express)

    • The lender MUST obtain a lien on assets financed with loan proceeds (assets that are purchased or improved) and the lender MUST obtain a lien on all of the applicant's fixed assets to the extent required to secure the loan.
    • If the business fixed assets do not "fully secure" the loan, the lender (i) MAY take personally owned investment and residential real estate of the principals as collateral; and (ii) MAY secure an applicant's trading assets (using 10% of current book value for the calculation) if it does so for similarly sized non-SBA guaranteed commercial loans.

    (3) Loans over $350,000.00

    • Lender MUST collateralize the loan to the maximum extent possible up to the loan amount.
    • The lender MUST obtain a lien on assets financed with loan proceeds (assets that are purchased or improved) and the lender MUST obtain a lien on all of the applicant's fixed assets to the extent required to secure the loan.
    • If the business fixed assets do not "fully secure" the loan, the lender (i) MUST take available equity in the personally owned investment and residential real estate of the principals as collateral; and (ii) MAY include trading assets (using 10% of current book value for the calculation) if it does so for similarly sized non-SBA guaranteed commercial loans.
      • Note: When an individual alone or an individual and his/her spouse together own 20% or more of the Small Business Applicant, the lender MUST consider as collateral available equity in the personally owned investment and residential real estate that is either owned individually by the applicant owner or owned jointly by the individual and his/her spouse. Real estate transferred to non-owning spouse within six (6) months of loan application is not exempt.

    While the SBA has relaxed its collateral requirements, Lenders are still faced with challenges when servicing and liquidating 7(a) loans because the SOP 50 57 2 provides a threshold of $5,000 for many of its liquidation procedures. Accordingly, Lenders must determine whether they are required to take fixed assets with a value of less than $5,000 at the time of loan origination. While it is always safest to take the collateral, many lenders rely upon the 50 10's over arching guidance to use commercially reasonable and prudent practices and make decisions regarding what collateral must be taken based upon the circumstances of the individual loan. This requires lenders who determine that the collateral is of "de minimus" value to document carefully and clearly why they are not taking the collateral, citing its insufficient benefit to the lender and SBA, and thereby reducing the costs to the small business and enhancing the likelihood of a successful loan facility. The key is always to document, document, document.

    For more information regarding SBA's collateral requirements, please contact Jen at [email protected] or at 267-470-1206 or Kristen at [email protected] or at (407) 667-8811.