SBA Lending Matters Newsletter
A Word from Arne

It’s well known that we’re all experiencing unprecedented economic times in which small business borrowers are struggling to access capital markets. The Small Business Lending Fund (SBLF), created by the Jobs Act of 2010, finally released its first wave of capital in July. So far the SBLF has provided funds totaling $418 million to 37 lending institutions. But the mood in Washington is one of fiscal restraint, and there’s little appetite for more stimulus funding.

As all government agencies come under scrutiny, the Small Business Administration is no exception.  In some quarters people are calling for the agency to be terminated altogether. So let’s take a look at some of the history behind the SBA, and some of the current numbers that reflect its continuing support of our country’s small business owners.

Established by Congress in 1953, the SBA’s purpose is to encourage lending to small businesses through credit enhancements. These enhancements allow small businesses to obtain credit with terms that are not available conventionally. According to size standards established by the SBA, more than 99% of businesses in the U.S. are classified as “small”. Thus the agency serves a large and underserved population.  In fact, the SBA fills the gap created by a “market failure” occurring in the delivery of capital to creditworthy borrowers.

In recent years leading up to the current financial crisis, the SBA generally cost taxpayers about $1 billion annually.  The yearly costs are calculated by totaling the agency’s operating costs and loan losses, less guaranty fees and servicing fees collected by the agency.  This year, because of an increase in SBA loan losses, the annual cost to taxpayers is estimated to be about $6.2 billion. This number is a reflection of the overall health of the banking industry itself. Just like other institutions in the financial sector, the SBA has suffered losses brought on by economic conditions and the credit situation.

So, is there justification for keeping the Small Business Administration in operation? SBA will guarantee nearly $24 billion in new loans in 2011.  If you embrace the premise that small businesses create a vast majority of jobs, pay most of the taxes, and create most of the wealth for owners, it seems logical to support the activities of the agency. I am a firm believer, however, that borrowers who make use of SBA programs should pay user fees so as to make the agency revenue neutral. The SBA’s user fee requirements were suspended with the enactment of the Recovery Act in 2009, but have since been reinstated. According to a recent article in HuffPost Business, in good economic times the fees paid by borrowers cover the cost of the 7(a) loan program, including defaults. This fact clearly dispels the notion that SBA loans are “corporate welfare”, as some have charged.

Those of us involved in the small business finance industry appreciate the fine efforts of the SBA, and we work very hard to assure its continued health.  Traditionally, small businesses have been the lifeblood of our economy. As the HuffPost article says, they’ve created the majority of new over the last decade and, in past downturns, the growth of small businesses has been what pulled us out of recession. And 54% of all small business lending comes from small and medium sized banks. When you support the SBA, you’re supporting community banks as well as your local economy.

Please call upon us here at H & M with any SBA related question or issue you may encounter. We can serve as your out-of-house SBA loan department as a qualified Lender Service Provider.  Holtmeyer & Monson – endorsed by the Independent Community Bankers of America – is happy to fill this need for your institution.

Featured Article

Best Practices: Adequate Collatera
By Kimberlee Knopf, Esq., Starfield & Smith, P.C.
http://www.starfieldsmith.com

Lenders are unable to extend conventional commercial loans to those Small Business Applicants who, though able to demonstrate repayment ability, lack collateral to repay the loan upon liquidation. SBA guaranteed lending programs enable lenders to extend loans to such Small Business Applicants; provided that an SBA guaranty is not "to be used as a substitute for available collateral." SOP 50-10-5(C) p. 190.

An SBA loan is deemed to be fully secured when the collateral has a combined "Liquidation value" up to the loan amount. SOP 50-10-5(C), Subpart B.II.A. defines "Liquidation value" as "the amount expected to be realized if the lender took possession after a loan default and sold the asset after conducting a reasonable search for a buyer and after deducting the costs of taking possession, preserving and marketing the asset, less the value of any existing liens." Business operating and trading assets (i.e. cash, inventory and accounts receivable) should not be assigned a value in excess of 10% of their current book value because such assets have little or no value upon liquidation.

In order for a lender to be assured that it is in compliance with these provisions, an SBA loan must, to the maximum extent possible, be collateralized with all available assets of a Small Business Applicant, including the available assets of the principals and their spouses, if the business assets are insufficient to fully secure the loan. Personal residences, deposits and securities of the individuals should be considered available assets for these purposes. If the equity in the personal residence of a principal(s) is more than 25% of the fair market value of the property then the principal(s) will be required to grant lender a lien on such real property as collateral for the loan. Subject to any applicable exemptions for publicly-traded assets, a lender should also consider certificates of deposit, securities and other investments not held in a retirement account, as collateral for its loan.

When an individual, or an individual and their spouse together own 20% or more of the Small Business Applicant, assets owned both jointly and individually must be considered as collateral for the loan. Even if a principal's spouse does not have an ownership interest in the Small Business Applicant, if the loan will not be adequately secured after review and analysis of the available assets of both the business and the principal, the assets of such spouse should be considered as collateral for a loan.

A lender must also consider the anticipated use of proceeds of the loan in its collateral analysis. When funding an asset purchase, a lender must, at a minimum, secure its loan with a first priority lien, mortgage and security interest in the assets being acquired by the Small Business Applicant. In the event a loan is intended to refinance existing indebtedness, the loan must, at a minimum, be secured by the same assets securing such refinanced debt.

A lender should be not be deterred in the event another lender will have a priority security interest in certain assets of the Small Business Applicant. For example, a lender may be funding a change of ownership resulting in 100% ownership by the purchasers. While the collateral must include a first priority lien upon the assets of the business, so long as a lender has considered all available assets to secure its loan, the lender may agree to take a subordinate lien on the accounts receivable if there is a reasonable justification for doing so (i.e. supporting the working capital needs of the business). It is noted, however, that any collateral subject to prior liens is not allocated any value in the determination of "Liquidation value".

So long as a lender is able to demonstrate that it has conducted a thorough analysis of the assets of the Small Business Applicant, the principals of the Small Business Applicant and their spouses in accordance with the foregoing and all other applicable provisions of the SOPs, rules and regulations, then its loan should meet the test for adequate collateral. Failure to obtain all available collateral on an SBA loan that is not otherwise fully secured will result in a repair or denial of the SBA guaranty.

For more information on SBA collateral requirements or other SBA related issues, contact Kim at [email protected] or 267-470-1226.


Regulatory Corner

SBA Revises Requirement for Reserve Accounts
On April 15th, SBA issued a Procedural Notice requiring all SBA lenders subject to certain regulatory restrictions such as Cease & Desist Orders and Consent Agreements to establish a Reserve Account Agreement if they wished to sell SBA loan guarantees in the secondary market.  Establishing the account became very cumbersome and counter-productive process. On June 10th, SBA revised the requirement, allowing the affected lenders with loans subject to secondary market sales to have those loans reviewed on a loan-by-loan basis.

Holtmeyer & Monson has established a protocol with SBA in order to expedite this loan-by-loan review. If your institution is subject to such regulatory restriction, and you wish to sell SBA loan guarantees in the secondary market, please contact us for further details.

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SBA Hot Topic

We’re regularly asked about the SBA requirement for lenders to take a security interest in a borrower’s personal collateral when the business collateral being offered – on a discounted basis - does not match the loan amount. Personal collateral may include personal residence or investment property, and is required when equity in the property exceeds 25% of fair market value. Another question concerns the lien amount required by the SBA when a second mortgage is used to shore up collateral. The amount is limited to 150% of the equity in the secondary collateral, rather than the full amount of the loan, if tax implications are associated with the lien amount.

 

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