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November 29, 2017

Best Practices: Revised Collateral Requirements with the Release of SOP 50 10 5 (J)

by Katie O'Brien

The Small Business Administration (“SBA”) has released SOP 50 10 5 (J), which takes effect on January 1, 2018. The new SOP sets forth changes with respect to franchise agreements, management agreements, equity injection requirements, the EPC rule, credit elsewhere, eligibility and collateral requirements, among other changes, many of which are beneficial to lenders and applicants. This article will focus on the changes to the SBA’s collateral requirements for 7a loans.

The SBA has long required that all individuals or entities owning 20% or more of the borrower must guarantee the loan. But the SBA has now expanded this requirement to state that SBA (or delegated lenders) may require other appropriate individuals or entities, despite their percentage of ownership, to provide full or limited guarantees when it is deemed necessary for credit or other reasons. SBA provides examples of a minority owner of the borrower (or a non-owner) who is critical to the operation of the business or an entity who manages the daily operations of borrower through a management agreement.

The new SOP also states that for small loans (equal to or less than $350,000), lenders are not required to take a lien against a borrower’s commercial real estate when the equity is less than 25% of the fair market value – previously, lenders were required to take a lien on all of borrower’s fixed assets, including real estate. Further, for loans over $350,000, lenders are not required to collateralize a loan with any real estate to meet the “fully secured” definition when the equity in the real estate is less than 25% of the property’s fair market value. Lenders must keep documentation in their file of the source, other than a personal financial statement, for determining the fair market value. Previous versions of the SOP contained a 25% equity exception for personally owned real estate, but did not contain the same exception for commercial real estate. The new SOP also allows unimproved real estate to be valued at 50%, rather than 85%, of the market value and furniture and fixtures can be valued at 10% of Net Book Value or appraised value for the calculation of “fully-secured.”

Another beneficial change involves the debt refinance collateral requirements. It has been the long-standing rule that the SBA loan must be secured with “at least the same collateral and lien priority as the debt that is being refinanced.” But SBA now adds a caveat – when the debt being refinanced is over-collateralized based on SBA’s collateral requirements and the SBA loan will remain fully secured, the lender may release the excess collateral. Further, lenders may substitute collateral if such collateral is of comparable value and useful life and is determined acceptable by SBA or the delegated lender.

See SBA Information Notices 5000-17008 and 5000-17009 for a summary of some of the key changes in the new SOP and refer to SOP 50 10 5 (J) to review all of the changes that will take effect January 1, 2018. For more information, contact Katie directly at kobrien@starfieldsmith.com or you can call her at 267-470-1207.