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New Year, New SOP: SBA’s Standard Operating Procedure 50 10 5(F) Brings Major Changes to SBA’s Loan

Author: Don Gwin and Kerry M. Southerland

In today’s economy, the U.S. Small Business Administration (“SBA”) loan program continues to be a principal channel for lenders to provide capital to their small business clients and, simultaneously, secure a 50% to 90% guaranty from the federal government. While SBA’s programs are certainly beneficial, they are not without risks. A lender must strictly comply with SBA’s regulations to ensure its success and that SBA honor its guaranty in the event the borrower fails. Such guidelines are outlined in the SBA’s Standard Operating Procedures (“SOP”) which was effectively updated on January 1, 2014.

The new SOP 50 10 5(F) has substantially revised provisions mostly regarding credit underwriting and collateral requirements in both the 7(a) and 504 SBA loan programs, and many of the changes reflect a continuation of SBA’s stated goals to streamline and simplify its loan program requirements. This article outlines the most important changes per the new SOP 50 10 5(F).

Eligibility:

  • PLP lenders will have the option of submitting to SBA franchise agreements not on the Franchise Registry for affiliation determination or eligibility review.
  • Fitness Centers that target one gender are now eligible if they are actually open to both genders.
  • PLP lenders are now authorized to clear minor (misdemeanor) 912 issues. 
  • A Religious Eligibility Worksheet (SBA Form 1971) is now included to provide guidance regarding eligibility determination.
  • New SBA Form 1919 (Borrower Information Form) replaces SBA Form 4, and new SBA Form 1920 (Eligibility Checklist) replaces SBA Form 4i. (SBA Form 1919 has been released, but the related SBA notice is silent as to the effective date.  SBA Form 1920 has also not yet been approved for use.  Lenders are to use the current forms until an official forthcoming notice from the SBA, and Lenders are not to use Forms 4 and Form 4i.)
  • SBA Form 912 has been revised.
  • The requirement for business valuations on the refinance of change in ownership transactions has been eliminated except where a seller note is being refinanced.
  • SBA’s policy on using 7(a) loans to refinance 504 loans has been clarified.  The following conditions must be met:
    • The transaction is used to refinance eligible business debt;
    • The new installment amount is at least 10% less than the existing installment amount; and
    • The lender’s loan file includes an analysis of the rationale for the transaction and either (1) both the 3rd party loan and 504 loan are being refinanced, or (2) the 3rd party loan has been paid in full, and the 504 loan needs to be refinanced as part of a larger transaction to provide for funding for expansion of or renovations to the subject project property.

Creditworthiness/Credit Underwriting:

  • All loans under $350,000.00 will be underwritten and processed using the Small Loan Advantage (SLA) credit analysis.
  • For loans over $350,000.00,  the new SOP provides the following definitions and requirements:
    • Operating cash flow (OCF) = earnings before interest, taxes, depreciation and amortization (EBITDA);
    • Debt service (DS) = required principal and interest payments on all business debt inclusive of new SBA loan proceeds; and
    • Debt service coverage ratio (OCF/DS) must be 1.15:1 or greater on a historical and/or projected basis.

Collateral:

  • Underwriting requirements now distinguish between loans of $350,000.00 and under, and loans over $350,000.00 up to and including $5 million.
  • For loans over $350,000.00, lenders must use commercially reasonable and prudent practices to identify collateral items. These loans must be collateralized up to the maximum extent possible up to the loan amount. 
    • The test for “fully secured” has been revised with a new formula including definitions of “Net Book Value” and “Orderly Liquidation Value”.
    • SBA now considers a loan as “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 (vs. old “Liquidation Value” formula).
      • For collateral purposes, adjusted Net Book Value is determined as follows:
        • New machinery and equipment may be valued at 75% of Net Book Value or 80% with an Orderly Liquidation Appraisal minus any prior liens;
        • Used or existing machinery and equipment may be valued at 50% of Net Book Value or 80% with an Orderly Liquidation Appraisal, minus any prior liens; and
        • Real estate may be valued at 85% of the appraised value.
  • The requirement for the pledge of non-real estate assets of principals has been eliminated.
    • If fixed assets do not fully secure the loan, the lender must take available equity in the personal real estate of the principals only as collateral (unless the equity is less than 25% of the fair market value).   
  • If fixed assets do not fully secure the loan, the lender may include “trading assets” (not defined).
  • For loans between the amounts of $25,000.00 and $350,000.00, lenders must follow their collateral procedures for similarly sized non-SBA loans (and at least take a lien on the business assets) but are not otherwise required to collateralize the loan up to the loan amount.
  • Certified Public Accountants are no longer a “qualified source” (qualified to provide a business valuation) unless he/she receives accreditation by a recognized organization (as listed in the SOP).

Loan Authorization:

  • Changes to Insurance Requirements
    • Language has been added for special hazard requirements.  Lenders are required to obtain a separate policy for wind, hail, and/or earthquake, as applicable, if required by the state.
    • Life Insurance requirements have been modified.
      • For loans in excess of $350,000.00 that are not fully-secured, life insurance is required only for the principals of sole proprietorships, single-member LLCs, or for businesses otherwise dependent on one owner’s active participation.
  • A provision regarding NEHRP (National Earthquake Hazards Reduction Program) has been inserted regarding a lender’s option to request modification to the Authorization to delete such requirement if the same it not applicable.

 Submission of Application for Guaranty:

  • The new SOP adapts a universal set of forms for all 7(a) lending, including standard 7(a), SBA Express and all pilot programs (Forms 1919/1920).
  • The new SOP requires that business financials and/or tax returns be dated within 180 days of submission to SBA.
  • Electronic submission is required for all standard 7(a), CLP and non-delegated CAPLine loans.

Post Approval Modifications, Loan Closing, and Disbursement:

  • All lenders will have the option to use their own note and guaranty agreements rather than SBA Forms 147, 148/148L, provided such forms are equivalent and the federal law applicability language is included. Per the SBA, it is NOT recommended that lenders use their own equivalent note if they intend to sell the guaranteed portion into the secondary market.
  • Form 1050 is no longer required for SLA loans.
  • PLP lenders must notify SBA through E-Tran servicing of many of the post-approval/pre-disbursement requests for changes, including cancellation of a loan, change in maturity date and change in legal name or trade name of the business or the borrower’s business address.
  • Changes regarding Working Capital CAP Lines
    • Language has been added to include the option for disbursement of line proceeds based on 1:1 collateral ratio (in lieu of a borrowing base, including the use of real estate appraised value at 85%).
    • Proceeds from cash sales and receivable collections must pay down the line “consistent with the borrower’s operating cash cycle”.
    • Language has been added to include receivables (as eligible to determine advance rate) under subcontracts which are foreign accounts receivable insured by the Export-Import Bank or a major private insurer in order to increase the maximum advance rate to 90%, and requirements for final disbursements.

504 Program:

  • General Provisions
    • Credit reports will no longer be required on non-guarantor affiliates. 
    • To verify a third party lender, a letter of intent, a term sheet or letter of commitment is acceptable for a 504 application.
      • If a letter of intent, term sheet or letter of commitment provides for preferences in collateral required by the 3rd party lender, the issuance of the Authorization is considered prior written consent of the SBA for such preference.
    • Additional guidance is provided as to when a 504 project may be approved and the additional conditions that will apply when the project involves industrial development bonds or industrial revenue bonds.
  • Eligibility
    • Includes the same clarifications as outlined above regarding franchise reviews, businesses with an associate of poor character, religious aspect or aspect of prurient nature identified above.
    • Clarification is also provided regarding energy public policy projects, permissible 504 debt refinancing and 504 projects that result in a change of ownership (also as outlined above).
  • Loan Application Procedures and Controls
    • SBA Form 1244 has been revised to eliminate the requirement of wet signatures on Exhibits 4, 6, 7 and 12: the personal financial statement, balance sheets and income statement, federal tax returns, and aging of accounts receivable.  The form also has been revised to reflect the credit reports that are no longer required for non-guarantor affiliates.  Several additional updates to the form are also noted.
    • CDCs are required to provide a copy of the full or partially executed purchase/sale agreements with 504 applications.
  • Closings and Allowable Fees
    • Updated guidance on the 504 closing process is provided including the number and types of documents submitted at closing, and SBA’s counsel’s responsibilities for the closing process.
    • Clarification is provided that CDCs are responsible for consulting the System for Awards Management/EPLS or successor system and SBA’s website to determine if an employee or agent has been debarred, suspended or otherwise excluded by SBA or another federal agency to ensure that they are not doing business with an agent during the time the agent is suspended or otherwise excluded from SBA programs.
    • The Central Servicing Agent (CSA) is updated to Wells Fargo Bank Corporate Trust Services.