Best Practices: Collateral Requirement Changes for 7(a) Loans

Collateral requirements for Standard 7(a) Loans (those greater than $500,00) and 7(a) Small Loans (those under $500,000) will be updated under the new SOP.

For 7(a) Small Loans, the collateral requirements were largely already based on the “do what you do,” concept prior to issuance of the new rules. Two significant changes in the Procedural Notices and SOP 50 10 7 are being implemented in the collateral requirements for small 7(a) loans. The first change is that the threshold minimum loan that requires any collateral is now set at $50,000.00 instead of $25,000.00. The second change is the removal of minimum collateral requirements for loans over $50,000.00 (and up to $500,000) – meaning the collateral requirements for these loans appear to be solely based upon “written collateral policies and procedures that it has established and implemented for its similarly-sized, non-SBA guaranteed commercial loans.”

For Standard 7(a) Loans (over $500,000), the analysis as to the identification and adequacy of collateral has also undergone some revision.  While the concept of “do what you do” is now incorporated into this analysis, the new rules still maintain certain minimum collateral requirements for these larger loans. Lenders must look to see if loans are fully secured, as discussed in further detail below. Lenders still must obtain a first security interest in all assets being acquired, improved, or refinanced with loan proceeds. One significant revision involves removal of language describing the impact of covenants and other restrictions may have on the value and marketability of real estate collateral have been eliminated as well as those of engineering controls associated with construction of improvements and remodeling of real estate property. Another revision removes clarifying language of how a lender is expected to handle assets held jointly by spouses.

Fully Secured Loans

To determine when a loan is “fully secured” a lender needs to take a two-step approach which is substantially similar to the existing rules and has not materially changed from current requirements.  First, the lender must take a lien on “all assets being acquired, refinanced, or improved with loan proceeds.” This differs from the earlier regulations which state that a lender must take a lien on “all available fixed assets.” Second, the lender must take a lien on all available fixed assets of the borrower with a combined Net Book Value up to the loan amount.  The adjusted Net Book Value of fixed assets did not undergo revision from previous SOPs, i.e., 75% for new machinery, 50% for existing machinery, 85% improved real estate, 50% unimproved real estate, and 10% of furniture and fixtures.

Loans not Fully Secured

If a loan request does not meet the foregoing definition of “fully secured,” the lender must take a lien on available equity in “personal real estate collateral” of certain individuals or entities, provided the equity in those properties exceeds 25% of the property’s fair market value.  Such liens on personal real estate property may be limited to the amount of the collateral shortfall.  In addition, liens on personal real estate may be limited to 150% of the equity in the collateral. This approach is substantially consistent with existing requirements. However, unlike previous versions of the SOP, the ability to cap liens is not dependent on there being adverse tax implication associated with the amount of the lien in the jurisdiction where the lien is to be filed.

While the concept of taking personal real estate collateral is not new, it now includes not only residential and investment property, but also specifically extends to “commercial real estate property.”  The individuals or entities called upon to pledge personal real estate collateral includes any owner of 20% of the borrower as well as certain guarantors.  Excluded from guarantors not required to pledge personal real estate collateral is a new type of guarantor referred to as  “supplemental guarantors.” This new class of guarantors are defined as: “a person or entity from whom a Lender requires to provide a guaranty out of an abundance of caution and who is not otherwise required by SBA Loan Program Requirements to provide a guaranty.”  SOP 50 10 7, Appendix 3, page 581.  This new concept appears only once in Appendix 3 of the new SOP and does not appear in the general guaranties section.

As of this writing, the SBA is reportedly working on technical corrections to SOP 50 10 7 expected to be published prior to the effective date of August 1, 2023.  Stay tuned.  For more information regarding SBA collateral requirements, contact the attorneys at Starfield & Smith at 215.542.7070.