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October 9, 2013

Best Practices: NEW Collateral Requirements under SOP 50 10 5(F)

by Kristen G. Dickey

With the release of the new SOP 50 10 5(F), effective January 1, 2014, comes significant revisions to the collateral requirements previously required by the SBA. The SBA is stepping away from the “all available collateral” rule with the recent changes.

Generally, under the new SOP, the SBA explains that with respect to collateral taken, lenders must 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. Specifically, though, the SBA separates the requirements for “adequate collateral” into three (3) separate 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.

Adequate Collateral

1. Loans of $25,000.00 loans or less

    • Lender is not required to take collateral for loans of $25,000.00 or less.

2. Loans over $25,000.00 but less than or equal to $350,000.00

    • At a minimum, the lender must obtain a lien on the applicant’s fixed assets to SECURE the loan. Lender may also secure an applicant’s trading assets (using 10% current of 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 with fixed assets to the maximum extent possible up to the loan amount. If fixed assets do not FULLY SECURE the loan, the lender must take available equity in the personal real estate of the principals as collateral.
      • Departure: Previously, other personally-held assets such as publicly-traded stocks, bonds, mutual funds, certificates of deposits and investment property not included in a retirement account could be pledged as collateral, if needed.
      • 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 personal real estate that is owned individually by the applicant owner as well as available equity in personal real estate owned jointly. Real estate transferred to non-owning spouse within 6 months of loan application is not exempt.
    • The SBA considers the loan “fully-secured” if the lender has taken security interests in all available fixed assets with a combined ‘net book value’ as adjusted up to the loan amount. See SOP 10 50 5(F) Subpart B, Chapter 4, Paragraph II.A(1)(f)
      • Liens on a personal residence or investment property may be limited to the amount of the collateral shortfall.
        • Departure: Previously, if the loan was not fully-secured, a lender was required to a take a lien for the full amount of the loan on secondary collateral even if the shortfall was a small fraction of the loan.
      • As before, liens 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.
      • SBA still does not require a lender to collateralize a loan to meet the “fully-secured” definition when the equity in the residence is less than 25% of the property’s fair market value.

Lien Priority

    • When loan proceeds will be used to purchase assets, a first security interest in those assets must be obtained.
    • When loan proceeds 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 financed.
      • Departure: Previously, the loan only had to be secured with the same security as the debt being refinanced. The SBA has clarified that the lien priority must also be the same.
    • Note: It is unclear whether these lien priority requirements apply to loans of $25,000.00 or less.

While the SBA provides specific direction to lenders as to what constitutes adequate collateral, ambiguity still exists in the new SOP language. For example, a lender that would typically take a personal residence as collateral for a similarly-sized non-SBA guaranteed commercial loan even when there is minimal value in the real estate must do so pursuant to the new SOP. However, this lender may have difficulty reconciling its standard practice with the SOP provision that states the lender is not required to collateralize a loan to meet the “fully-secured” definition when the equity in the residence is less than 25% of the property’s fair market value.

Lenders should take care in analyzing the collateral and ensure they are complying with the current regulations to secure the SBA guaranty. For more information regarding available collateral, please contact Kristen at 407.667.8811 or at kdickey@starfieldsmith.com.