SOP 50 10 5(F) & Issues relating to SBA Loan Problems
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The Small Business Administration’s SOP 50 10 5(F) became effective January 1, 2014. This latest version has significantly revised SBA requirements in both the 7(a) and 504 loan programs. This article highlights the most important changes in the program requirements.
Franchise/License/Dealer or Similar Agreements
The SBA substantially revised franchise eligibility requirements for both 7(a) and 504 loans. SBA requires a determination as to whether affiliation exists when the applicant has or will have a franchise, license, dealer, jobber or similar relationship and such relationship (or product, service or trademark covered by such relationship) is critical to the Small Business Applicant’s business operation. In order for a lender to rely on the SBA Franchise Registry, the loan file must include:
a) Executed franchise agreement and any approved attachments and exhibits;
b) Executed Addendum (if required);
c) Executed Certification of Franchise Documents; and
d) Compliance with any required eligibility notes.
If the franchise agreement is not listed on the Registry or the lender chooses not to use the Registry, the SBA must review the agreement and all related documents. Lenders may contact SBA counsel in the District Office or the SBA Chief Franchise Counsel for specific questions regarding franchise affiliation determinations.
This SOP includes new requirements and exceptions for ineligible businesses for both 7(a) and 504 loan processing. Businesses engaged in promoting religion (new Form 1971 to be completed to determine whether there may be a religious component to the business which would make the business ineligible) are ineligible for the SBA guaranty. However, there is an exception where an applicant merely offers religious books, music, ceremonial items and other religious articles for sale.
Regarding businesses engaged in lending services, which generally are ineligible, a business engaged in providing the services of a financial advisor on a fee basis is eligible so long as the business does not use funds to invest in its own portfolio of investments. The SOP also clarifies that casinos and mutual betting racetracks are not eligible, regardless of the percentage of gross revenue derived from gambling.
The lender has additional obligations if it discovers that an applicant’s business may include activities of a prurient sexual nature, including documenting its findings, which must be submitted to the SBA (either for Loan Guaranty Processing Center for non-delegated lenders, or upon repurchase for Preferred Lender Program lenders). In addition, there are now additional collateral requirements for businesses owned in part by foreign nationals or foreign owned businesses in excess of 50%.
The SBA has substantially revised the requirements for 912 clearance and the revised SOP to address the questions on the new Form 912. A business is ineligible where the principal is subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges. Electronic Fingerprint Submissions that comply with the FBI’s Electronic Biometric Transmissions Specifications may be submitted in lieu of the Fingerprint Card. A delegated lender (for loans processed under delegated authority) may process, submit and disburse the loan only when the subject’s affirmative activity meets the criteria set forth below:
(a) A single minor (misdemeanor) offense or arrest; OR
(b) Up to three minor offenses (arrests and/or convictions at one time or separately), concluded more than 10 years prior to the date of the SBA application; OR
(c) A prior offense cleared by the Director, Office of Financial Assistance (D/FA) or designee on a previous application where no other offenses have occurred since the previous application was cleared by the D/FA or designee.
Refinance of an Existing 504 Loan and other Loans With a 7(a) Loan
An existing 504 loan may now be refinanced using a 7(a) loan if: (i) the transaction is used to refinance eligible business debt, (ii) the new installment amount is be at least 10 percent less than the existing installment amount(s), and (iii) the lender’s loan file includes an analysis of the rationale for the transaction (meeting the requirements set forth in the SOP for debt refinancing) and either:
a) Both the Third Party Loan and the 504 loan are being refinanced; OR
b) The Third Party Loan has been paid in full and the 504 loan needs to be refinanced as part of a larger transaction to provide funding for expansion of or renovations to the Project Property. In either case, the lender must document its loan file as to the justification to refinance the existing SBA-guaranteed 504 loan. Any applicable 504 prepayment penalties will apply.
The SBA also has revised the documentation requirements for refinancing SBA guaranteed loans to identify what the current lender must retain in the loan file. Refinance of non-SBA debt with SBA guaranteed debt by the same lender provides additional guidance to confirm whether debt has been current.
When using a CAPLine to refinance debt, the lender can use the test of sufficient collateral to support the line (previously, debt refinance transactions with a CAPLine were limited to lines of credit where borrowing bases are used).
Loan Terms and Conditions
The SBA clarified that when determining maturities, a lender must determine the shortest appropriate term based on the use of proceeds and the borrower’s ability to repay. The previous version of the SOP left more discretion for the lender to determine an appropriate term. When determining a repayment period, a lender should include in the loan file support for maturities that exceed a standard for an asset class, making sure that the maturity does not exceed the stated maximum. When a lender changes an interest rate after approval and prior to disbursement, the lender must notify the LGPC of the change. After final disbursement, the lender should send notice to the appropriate Commercial Loan Servicing Center. As a reminder, any change in the interest rate or spread requires the written consent of the borrower.
The SOP underwriting requirements now distinguish between loans of $350,000 and under and loans in excess of $350,000. All loans of $350,000 and under must now be underwritten using the Small Loan Advantage (SLA) credit standards. All applications are to be credit scored through E-Tran as all SLA loans have been in the past. The Lender also must complete a credit analysis that:
Demonstrates the applicant’s ability to repay the loan from cash flow;
Analyzes the strength of the business to determine creditworthiness using key characteristics, such as Credit/Deposit behavior data, current consumer credit bureau data and other available data;
Verifies of the applicant’s financial data by submitting an IRS Form 4506-T, which must be obtained prior to submission of the SLA application; and
Reviews the equity and pro-forma debt to worth based on its policies for similarly sized non-SBA guaranteed loans. If a lender requires an equity injection for non-SBA guaranteed loans, it must do so for SBA loans.
Lenders may use their own credit scoring criteria and credit history of the applicant and the operating company (if applicable) as well as guarantors.
The requirements for loans in excess of $350,000 also have been augmented. As in the past, the lender’s analysis of the loan application must demonstrate the applicant’s ability to repay the loan from cash flow of the business. The SOP now goes into further detail as to the required analysis. The SOP now requires a debt service coverage ratio of at least 1.15:1 based on a historical or projected basis. Cash flow analysis should be done on an EBITDA standard.
The SOP clarifies that the equity injection requirements apply for loans in excess of $350,000.
Collateral Requirements – 7(a) loans
The SOP now differentiates between loans of up to $350,000 and loans in excess of $350,000.00. For loans in excess of $350,000, lenders must use commercially reasonable and prudent practices to identify collateral items (which must conform to the procedures in place with the lender for their similarly sized non-SBA guaranteed commercial loans). These loans must be collateralized to the maximum extent possible up to the loan amount. If fixed assets do not fully secure the loan, then the lender may include trading assets (the term is not defined in the SOP) and must take available equity in the personal real estate of the principals as collateral.
What is significant here is that the new SOP deletes the requirement to take other personally held assets (i.e., stocks, certificates of deposits, mutual funds) in order to meet the all available collateral test. If the loan is between $25,000 - $350,000, the lender should follow its collateral procedures for similarly sized non-SBA guaranteed loans (and at least take a lien in the business assets) but is not otherwise required to collateralize the loan up to the loan amount. As in the previous edition of the SOP, loans less than $25,000 do not require collateral.
The test for “fully secured” also has been revised and creates a new formula with definitions of Net Book Value and Orderly Liquidation Appraisal. Lenders may now use 75% of Net Book Value or 80% of Orderly Liquidation Value to determine if a loan is fully secured. For real estate, a lender may use 85% of the appraised value. If a collateral shortfall based on this new formula exists, then trading assets (using 10% of the current book value) and available equity in personal real estate of the principals will be required (unless the equity is less than 25% of the property’s fair market value), although the lien on the residence may be limited to the collateral shortfall. In the event there are tax implications, 150% of the equity in the personal and investment property may be used instead of the loan amount. Significantly, the SOP does not define the term “trading assets.” Lastly, if a non-owner spouse owns real property in his/her own name, the property owned by that non-owner spouse is not subject to the collateral requirements (unless the property was transferred within a six-month period prior to loan application).
If the amount being financed (including any 7(a), 504, seller, or other financing) minus the appraised value of real estate and/or equipment being financed is $250,000 or less, the lender may perform its own valuation of the business being sold, unless the lender’s internal policies and procedures require an independent business valuation from a qualified source. The SBA has eliminated the requirement for business valuations for the refinance of change of ownership transactions except where a seller note is refinanced. A CPA is no longer qualified to provide a business valuation unless the CPA also is accredited with one of the organizations set forth in the SOP.
For loans less than $350,000, lenders may use their own internal policies for similarly sized non-SBA guaranteed commercial loans. For loans in excess of $350,000, the internal policies also govern, provided that if the loan is not fully secured, life insurance is required for the principals of sole proprietorships, single member LLCs or other businesses otherwise dependent on one of its active participants. Lenders may factor in the type of collateral and amount available to repay the loan in determining the amount of life insurance required. If an applicant is uninsurable, a lender must obtain written documentation from a licensed insurer.
Hazard/Flood Insurance - 7(a) and 504 Loans
If a state requires additional coverage such as wind, hail, earthquake or other, then the borrower also must provide this coverage. Only FEMA form 086-0-32 may be used after May 30, 2015 (currently, lenders may also use FEMA form 81-93).
Construction - 7(a) and 504 Loans
Where any leasehold improvements are permanently affixed to the real estate, then the lender must document that the NEHRP (earthquake) standards are being complied with. If the borrower can document that the improvements are temporary, then the borrower need not comply with the NEHRP standards. The Authorization should be modified in accordance with the SOP requirements if NEHRP standards are not required.
Changes in the CAPLine requirements include allowing for disbursement of proceeds for Working Capital CAPLines based on a 1:1 collateral ratio (in lieu of a borrowing base, including the use of real estate appraised value at 85%), clarification that the proceeds from cash sales and receivable collections to pay down the line “consistent with the borrower’s operating cash cycle,” inclusion of receivables under subcontracts which are foreign accounts receivable insured by the Export-Import Bank or a major private insurer in order to increase the maximum advance rate to 90%, and requirements for final disbursements.
The SOP extended the expiration dates for financial statements to 180 days instead of 120 days.
Use of Note (Form 147), Guaranty Forms (Forms 148 and 148l) and 1050
In a significant deviation from the prior requirements, lenders may now use their own form notes and guaranties instead of using the SBA created forms. If the lender uses its own form loan documents, it must insert certain language in each document and the repayment terms must be identical to the repayment terms set forth in the Authorization. While lenders still are required to document each disbursement under an SBA-guaranteed loan, the Form 1050 is no longer required for SLA loans.
PLP lenders must notify SBA through E-Tran servicing of many of the post approval/pre-disbursement requests for changes, including cancellation of a loan, change in maturity date and change in legal name or trade name of the business or the borrower’s business address.
Lender Applications For Loan Guaranty
Lenders now must submit the applicant’s SBA Form 1919, “Borrower Information Form.” The Form 1919 includes the certifications and requirements previously set forth in SBA Forms 601, 912, 1261, and 1624. In addition, the requirements imposed by laws and executive orders concerning floodplains and wetlands management, lead based paint, earthquake hazards, the Right to Financial Privacy Act, among others are included in SBA Form 1919. In addition, lenders must submit SBA Form 1920SX. This form identifies eligibility issues. Applications for the loan guaranty must be sent electronically. For non-PLP lenders, the package of documents submitted to the SBA must include documents required based on the conditions of the loan (i.e., appraisals, if real estate, purchase and sale agreements if there is a change of ownership, etc.).
504 Credit Standards
This new SOP clarifies that credit reports are required only for the small business concern, its owners and affiliates who are guarantors. Non-guarantor affiliate credit reports are not required. The type of documentation required to verify a third party lender includes a letter of intent, term sheet or commitment letter. If a letter of intent, term sheet or commitment letter provides for preferences in collateral required by the Third Party Lender, then the issuance of the Authorization is considered the prior written consent of the SBA for such preference. The SBA may now participate in projects financed in part by obligations exempt from state or local taxes (such as real estate taxes). This would include industrial development bonds or industrial revenue bonds provided certain conditions are met.
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