Collateral: It’s Not Just What You Do, But How You Do It

August 10, 2015

Walter McLaughlin
Coleman Report Contributor
Senior Vice President
Banner Bank

Ever heard the phrase, “It’s not just what you do, but how you do it?” Although the first part is definitely important in SBA lending, the second keeps your guaranty in good shape in the event of a repurchase.

Consider the issue of collateral.

The SBA’s emphasis on cash flow is clearly stated in the 5010 5(H): “The cash flow of the Small Business Applicant is the primary source of repayment, not the liquidation of collateral.”

Given that overarching philosophy, SBA doesn’t make a federal case (pardon the pun) over whether or not a loan is fully secured. Good thing, as lenders regularly use 7(a) guarantees to mitigate collateral shortfalls.

But you don’t get an automatic free pass during a purchase request, especially if the loan goes sideways within the first 18 months. The 50 57 indicates the SBA may review your credit analysis after an early default to determine if there were any serious analytical errors or obvious misjudgments during the underwriting process — even if all available collateral was pledged.

Nevertheless, determining the collateralization of an SBA loan is vital toward preserving the guaranty. The SBA’s general collateral policy on term loans requires at least a first lien on assets being financed with loan proceeds and a lien on the business’ remaining fixed assets for all loans over $25,000. In addition:

If the loan is $350,000 or less: The lender is allowed to follow its existing policies and procedures with respect to collateral, provided — at a minimum — it takes a first lien on financed assets and a lien on the other fixed assets of the business.

If the loan is $350,000+: In addition to business fixed assets, the guarantors’ personal real estate should be pledged if there is a collateral shortfall, provided it has at least 25% equity.

Assuming they are not already pledged against a line of credit, inventory and receivables may be factored into the analysis as additional collateral, but SBA only counts 10% of their values when it comes to determining if a loan is “fully secured.” That’s critical when the lender is determining whether personal real estate must be pledged against the loan. Your institution is free to assign a higher liquidation factor for general underwriting purposes if it wishes, but anything above 10% won’t be given weight when SBA determines whether or not you should have taken personal real estate.

The SOP provides guidance as to advance rates to be used in the calculation of whether or not a term loan is “fully secured”:

  • Real estate: 85%
  • New equipment: 75% of purchase price
  • Existing equipment: 50% of net book value or 80% if valued by an Orderly Liquidation appraisal, both minus prior liens.
  • Inventory and accounts receivable: 10%

As important as it is to utilize these factors, documenting and applying them correctly is essential to avoid a repair or denial of your purchase request.

After all, with respect to SBA lending, it’s not just what you do, but how you do it.