Challenges with Available Collateral and SBA Loans

Small Business Administrative (SBA) loan requests are not to be declined solely on the basis of inadequate collateral.  Lenders can use the SBA program for borrowers that can show they have an adequate repayment ability and cash flow but have inadequate collateral to fully secure and repay the loan if it defaults. 

SBA will require that the loan must be “fully secured”.  This means that the loan must have a security interest in all available assets with a combined liquidation value up to the loan amount.  “Liquidation value” is the net amount expected to be received after the asset is sold.  This net amount considers all care and preservation expenses and existing liens have been taken care of. 

As a lender, the SBA requires you to identify all available collateral and determine the liquidation value of each one.  The liquidation value may be determined by the lender based upon their conventional or SBA lending policies. These must be consistently applied from loan to loan.  The SBA does not define exactly how a borrower’s personal residence should be valued.

In the SBA Standard Operating Procedure (SOP) 50 10 5(E), Chapter 4, the SBA does require that lenders secure each loan to the “maximum extent possible up to the loan amount”, utilizing the assets tied to the borrowing business as well as the personal assets of each principal.  It does not matter if those personal assets are owned individually or jointly.

If the loan is not fully secured, the lender should determine and certify that no additional collateral is available.  This should be documented in the file.  If there is a collateral shortfall, this should be mitigated by the other strengths in the file.  If other assets are available, they should be taken as collateral.

In the SBA 7(a) loan, it is a common practice to take the borrower’s primary residence as additional collateral for the loan to prevent a shortfall or impairment to an SBA Guaranty, in the event of liquidation or default at a later date.  There are two exceptions to this rule:

1.  A personal residence that has equity less than 25% of the property’s fair market value.

2.  When there is a legal impediment, such as an irrevocable trust or a prenuptial agreement, that prevents the borrower from using a spouse’s individually-owned property to secure a loan.

In the SBA 504 loan, it is extremely rare for a Borrower’s personal residence to be taken as additional collateral.  This may be more desirable to the member.

Proper handling and securing of collateral when using an SBA loan will provide protection for your Guarantee.  The SBA program should not be used to place a marginal loan on your books.  A problem loan that has an SBA guarantee will require a lot of your time and effort to manage the credit.  The SBA program should be viewed as a way to help mitigate the risks for a good credit that may have some weaknesses in the collateral coverage.