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April 22, 2011

Firm News for April 2011: Best Practices: Using an SBA 7(a) Loan to Refinance 504 Project Related Debt

By: Michele L. Courneya, Esq.

A familiar rule in using an SBA 7(a) loan for refinancing an existing debt is: “third party financing for an existing 504 project cannot be refinanced with a 7(a) loan. (13 CFR 120.920(b)).” See SOP 50 10 5(C) at page 145. SBA has also traditionally maintained that a lender could not refinance BOTH the third party loan and the 504 debenture, or ONLY the 504 debenture, using a 7(a) loan because the 504 loan was presumed to be on reasonable terms. However, when SBA changed the eligibility rules for refinancing under the 7(a) program, this expanded the opportunities to use a 7(a) loan to refinance debt related to a 504 project in the following instances:

1. If the borrower has paid off the 504 debenture in full, the third party financing is NOT for an existing 504 project. After the debenture has been paid off, the third party debt is treated as any commercial debt and may be refinanced using a 7(a) loan if the debt is otherwise eligible for refinancing under SBA rules. Document that the 504 debenture has been paid in full. You can double check the borrower’s information and documentation by contacting SBA, the CDC, or Colson and checking that the status of the 504 loan is listed as Paid in Full. Do not process the loan PLP if you have any doubts;

2. An SBA 7(a) loan may be used to refinance BOTH the third party loan and the 504 loan for an existing 504 project, provided the lender demonstrates and documents:
a. That the existing financing no longer meets the borrower’s needs, and is no longer on reasonable terms;
b. The new installment amount is at least 10 percent less than the existing installment amount(s);
c. The new loan will clearly improve the financial condition of the borrower;
d. The Lender follows the requirements for refinancing SBA Guaranteed Loans listed in SOP 50 10 5 (C) at page 144 for the 504 loan; AND
e. There is adequate collateral to fully secure the new 7(a) loan. Full collateralization is required because when an entire 504 project is refinanced using a 7(a) loan, SBA’s exposure increases from 40% to 75% of the total project debt. Also, because in some cases 504 loans are not fully secured, additional collateral may be required to fully secure the 7(a) loan.
SBA has advised that, due to the complexity and the policy interpretations necessary, these requests should be processed by SBA at the Standard 7(a) Loan Guaranty Processing Center (LGPC). To preserve the guaranty, Lenders should not process these loans under PLP authority. Of course, if the third party loan is “Same Institution Debt”, it must be processed through standard processing procedures; and

3. An SBA 504 debenture may be refinanced using a 7(a) loan if the lender meets the criteria listed in 2 above, AND SBA gets a shared first lien position on the collateral that secures the loan. Without a shared first lien position, the loan is in an ineligible “piggyback” structure, and an unacceptable preference is created, rendering the loan ineligible for SBA financing. In this case, SBA prefers, and we recommend, that these applications be submitted under standard processing procedures, and not PLP authority, especially if your institution is the third party lender on the 504.

While refinancing 504 related debt may be eligible in these circumstances, these kinds of refinancing requests are not commonplace and are subject to higher scrutiny by SBA in determining whether there is a substantial benefit to the borrower. By following these best practices, you can avoid a potential repair or denial to your SBA guaranty.

For more information regarding SBA debt refinancing rules, contact Michele at mcourneya@starfieldsmith.com or 215-542-7070.