Bill is a competent but relatively new loan officer. His bank is a JRB client, so I knew he was presenting a 7(a) loan to his loan committee. I expected all to go smoothly. Not so. Bill called me right after the meeting. Here’s what happened:
BILL. During my presentation, a committee member noted that my recommendation for approval didn’t include a requirement to lien the accounts receivable and inventory. He asked, “Doesn’t SBA require that we take a lien on trading assets?”
I responded that the loan would be secured by the business’ equipment. And that when I discounted the equipment to its liquidation value there was more than enough equity to cover the amount of the new loan. Then the guy told me he remembered that SBA requires taking a lien on “all available collateral.” Help, Richard. Can you clear this up? My loan is at stake.
ME. Sure. Rest easy, Bill. SBA’s collateral requirements have changed over time. Years ago, SBA had a “low doc loan” program and one of its requirements was that the borrower pledge “all available collateral.” That requirement has been modified over the years and the term “all available collateral” is nowhere in the SOP.
Lenders avoid the term “Low Doc Loan” because it conjures up the specter of the Great Recession, and they still mistakenly think that SBA requires a lien on all available collateral. They get to the point in the SOP where it says that a loan is fully secured “… if the Lender has taken security interests in all available fixed assets …” and stop reading before they get to the words. “… with a combined Net Book Value … up to the loan amount.” (50 10 6 pg. 257)
There is no requirement to “over-collateralize” a loan or to take collateral for its psychological value. Such a lien may inhibit growth of the business in the future.
BILL. You’re always good for a history lesson, Richard. Thanks. But what about current affairs? What are the collateral requirements now?
ME. There’s a kind of hierarchy: First, you lien the assets you’re financing. For example, if the loan proceeds will be used to purchase equipment, you lien the equipment. You discount its value to the SBA’s liquidation value. (SOP 50 10 6 pg. 257) If there’s still a collateral shortfall, only then are you required to lien all available fixed assets.
BILL. Wait, didn’t you just tell me that I don’t need to lien all available assets?
ME. If your loan isn’t fully secured by the assets you’re financing, SBA requires a lien on all available fixed assets.
BILL. Just the fixed assets, right? Not all the assets?
ME. Correct. The key term here is “fixed assets.”
BILL. OK. But what if there’s still a collateral shortfall after we discount all available fixed assets to SBA’s liquidation value? Then do we finally lien the trading assets?
ME. Whoa! Not so fast!! If there’s still a collateral shortfall, you must—-it is not optional—lien the owner’s personal real estate according to SBA’s rules before you get to the trading assets. (SOP 50 10 6 pgs. 257-258)
BILL. When do we get to lien their accounts receivable and inventory?
ME. Oh, you can always put a lien on them if you do that for your other commercial loans of the same size that aren’t guaranteed by the SBA. But I wouldn’t recommend it because you’re tying up assets that the business may need for working capital. You might be stymieing the growth of the small business, which of course is contrary to the whole purpose of SBA lending.
At the end of our conversation, I felt a great deal of satisfaction, having supported our client—and having exploded yet again the myth of taking a lien on “all available collateral.”