Aug 23, 2017
Are you confident your SBA loans are “fully secured”?
For SBA lenders the threat of repairs and/or denials for SBA-backed guaranties begin before any funds exchange hands. When lenders determine a borrower’s eligibility, they must be meticulous in their valuations of the collateral and prove that verification of the collateral used to secure the loan is in line with the provisions of the Standard Operating Procedures (SOPs). The SOPs state that a loan request is not to be declined solely on the basis of inadequate collateral. However, the SBA does not permit its guaranty to be a substitute for available collateral. In regards to the adequacy of the collateral pledged, the lender is required to use “commercially reasonable and prudent practices” to identify collateral; although, there are minimum requirements that must be adhered to:
I. General requirements for all 7(a) loans
When assessing the adequacy of the collateral, the lender must consider the impact of covenants or other restrictions recorded against the collateral that may have an effect on its value and marketability. For all 7(a) loans, the lender must also consider both what to take as collateral and how to value that collateral:
a. If loan proceeds from any 7(a) loan will be 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.
b. The SBA considers a loan “fully secured” if the lender has taken security interests in all available fixed assets with a combined “net book value” as adjusted below and up to the loan amount. For 7(a) loans, the term “fixed assets” means real estate, including land and structures, machinery and equipment owned by the business or an EPC. “Net book value” is defined as an asset’s original price minus depreciation and amortization. Regarding the valuation of the collateral:
- New machinery and equipment may be valued at 75 percent of price minus any prior liens for the calculation of “fully secured.”
- Used or existing machinery and equipment may be valued at 50 percent of Net Book Value or 80 percent with an Orderly Liquidation Appraisal minus any prior liens for the calculation of “fully secured.”
- Real estate can be valued at 85 percent of the market value for the calculation of “fully secured” and the value must be determined in accordance with the requirements set forth in paragraph C of the SOPs.
- If there is a collateral shortfall (not fully secured) on the SBA-guaranteed loan, the lender may include trading assets as necessary (using 10 percent of current book value for the calculation) and will be required to take available equity in the personal real estate of the principals. Liens on a personal residence or investment property may be limited to the amount of the collateral shortfall.
- Liens on a personal residence or investment property may be limited to 150 percent of the equity in the collateral if there are tax implications associated with the lien amount in the particular state where the lien is filed.
- For loans that are more than $250,000 and collateralized by commercial real estate, lenders must comply with the appraisal requirements set forth in paragraph II.C, 1 of the SOPs.
- SBA does not require a lender to collateralize a loan with personal real estate to meet the “fully secured” definition when the equity in the real estate is less than 25 percent of the property’s fair market value.
II. Requirements for all 7(a) loans over $350,000
a. General Requirements
- For loans in excess of $350,000, SBA requires that the lender collateralizes the loan to the maximum extent possible up to the loan amount. If a business’ fixed assets do not “fully secure” the loan in accordance with the aforementioned requirements, the lender may include trading assets (using 10 percent of current book value for the calculation) and must take available equity in the personal real estate (residential and investment) of the principals as collateral. The lender is not required to collateralize a loan with a lien on personal real estate to meet the “fully secured” definition when the real estate equity is less than 25 percent of the fair market value.
b. Assets owned by all small business applicants and spouse
- When an individual alone or together with his or her spouse owns 20 percent or more of the small business applicant, the lender must consider taking as collateral a lien on personal real estate (investment or residential) that is owned individually by the applicant owner or jointly owned by the individual and his or her spouse.
- Real estate transferred by the applicant to the non-owning spouse within six months of the date of the application will not be exempt from consideration as available collateral.
Ensuring a lender follows the SOPs before a loan is closed will prevent costly denials and repairs in regards to the lender’s SBA backed guaranty. It is important for lenders to not only have an experienced team internally to service its loans but to also use vendors, including attorneys, that have vast SBA experience which assures SBA compliance on all levels.
This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.
Client alert authored by: Sarah K. Lash, Principal
This alert originally appeared in the Fall 2017 Banking Focus newsletter.
 See SOP 50 10 5(I), Chapter 4.
 SOP 50 10 5(I), Chapter 4, Section II, Paragraph C.
 SOP 50 10 5(I), Chapter 4, Section II, Paragraph C, 1.