Best Practices: Lenders Need to Work Closely with CDCs to Avoid 504 Loan Approval Delays

Third Party Lenders participating in the SBA’s 504 Loan Program should become familiar with new, specific matters that must be included in a CDC’s financial analysis of the borrower and documented in the CDC’s credit memorandum, for all loans made during the COVID-19 emergency through at least December 31, 2020.  In SBA Procedural Notice 5000-20040, effective July 28, 2020, the SBA requires the CDCs to perform an additional financial analysis of the borrower’s ability to repay the loan in light of the ongoing pandemic.  These new requirements address the adverse impact the COVID-19 emergency may have had on the operations of small business borrowers and the resulting negative effect on their cash flow and corresponding ability to repay the loan.  

As with the 7(a) loan program, the cash flow of the borrower is the primary source of repayment for 504 loans.  Regardless of available collateral, if a prospective borrower lacks a reasonable ability to make loan payments in a timely manner from the cash flow of the business, the 504 loan request should be declined.  The SBA has enumerated eight COVID-specific criteria that must be addressed in the CDC’s credit memorandum, as follows:

1. Does the prospective borrower have any other loan(s) (PPP, EIDL, or other stimulus financing, etc.) that have repayment or contingent repayment requirements that could impact cash flow? If yes: (i) what is the status of the loan (on deferment, past due, for PPP loans forgiveness application in process etc.); (ii) what is the cash flow during and after any payment deferment period; (iii) what will the cash flow be if the loan is fully, partially or not forgiven; and (iv) what lien position will the new 504 loan have?
2. How has the industry and the business of the prospective borrower been impacted by the COVID-19 emergency? Have their revenue and staffing levels been impacted, and have they provided a plan to return to normal operations.
3. Are there stay-at-home orders where the potential borrower plans to operate? When are the orders scheduled to be lifted, and how have the orders affected their ability to operate (social distancing, traffic flow, trade restrictions, inventory and equipment needs)?
4. Does the potential borrower have a concentrated or diversified customer base? How reliant are they on sales to or receivables from customers in those concentrations?
5. How concentrated or diversified is the potential borrower’s vendor/supplier pool, and which, if any vendors/suppliers have decreased ability to support the business?
6. If using historical financial data, an explanation of why the data is a reliable indicator of the potential borrower’s ability to meet all business obligations, including the proposed loan’s debt payments, in light of the current economic impact of COVID-19, or provide pro forma monthly cash flow statements for up to 2 years (based on phased reopening) with a break-even analysis.
7. Discussion of the impact current market conditions have on collateral adequacy.
8. For loans funding by September 2020, the CDCs need to consider whether loan approval should be conditioned on the execution of a COVID-19 Agreement.

With the adoption of the 25 year debentures, the volume of SBA 504 loans has increased significantly.  Concurrent with the increase in loan volume, and the significant impact the COVID-19 emergency has had on the operations and personnel of all government agencies, has come an understandable delay in processing periods by the Sacramento Loan Processing Center.  By partnering with CDCs in addressing the SBA’s new requirements proactively, Third Party Lenders can help avoid unnecessary delays caused by screen outs requesting the missing information.  For questions regarding SBA 504 loan originations during COVID-19, please contact the attorneys at Starfield & Smith at 215-542-7070.