NAGGL SUMMARY
Final Rule
AFFILIATION AND LENDER CRITERIA FOR THE SBA BUSINESS LOAN PROGRAMS
88 FR 21074
[Link to Final Rule: Affiliation and Lending Criteria for the SBA Business Loan Programs]
Summary: The U.S. Small Business Administration (SBA or Agency) is amending various regulations governing SBA’s 7(a) Loan program and 504 Loan Program, including regulations on use of proceeds for partial changes of ownership, lending criteria, loan conditions, reconsiderations, and affiliation standards, to expand access to capital to small businesses and drive economic recovery. The amendments to affiliation standards will also apply to the Microloan Program, Intermediary Lending Pilot Program, Surety Bond Guarantee Program and Disaster Loan programs (except for the COVID Economic Injury Disaster Loan (EIDL) Disaster Loan Program).
On October 26, 2022, SBA published a notice of proposed rulemaking and request for comments in the Federal Register [87 RF 64724]. The comment period closed on December 27, 2022. SBA received a total of 146 comments on the Proposed Rule.
The Final Rule was published in the Federal Register on April 10, 2023 [88 FR 21074], and will take effect 30 days after publication, May 11, 2023. It essentially adopts all the amendments included in the Proposed Rule with only two substantive changes, as noted in the section-by-section summary below, and a few minor language changes.
As of April 10, 2023, SBA’s Proposed Rule on Small Business Lending Company (SBLC) Moratorium Rescission and Removal of Requirement for a Loan Authorization [87 FR 66963] remains pending. That proposal was issued November 7, 2022, with its comment period closing on January 6, 2023. Also pending is the issuance of version 6.1 of SOP 50 10. NAGGL expects the revised SOP to provide additional guidance regarding the changes including in both Final Rules and to make other significant changes to SBA Loan Program Requirements.
Regulations being amended – 13 CFR 120, Business Loan Programs, and 13 CFR 121, Small Business Size Regulations.
13 CFR 120, Business Loan Programs
13 CFR 120.130, Restrictions on uses of proceeds and 13 CFR 120.202, Restrictions on loans for changes of ownership [Language in both sections of the Proposed Rule was slightly amended to clarify this changes.]
- SBA revised 13 CFR 120.130 to remove the previous prohibition against using loan proceeds to finance partial changes of ownership. With the regulatory change, loan proceeds can be used to “purchase a portion of or the entirety of an owner’s interest in a business, or a portion of or the entirety of the business itself”.[In the supplementary information, SBA clarified that it intends to allow a selling owner to “remain as an owner and involved in the day to day business, including as an officer, director, Key Employee, or employee”.]
- SBA also revised the regulations to exempt payments made to “facilitate changes of ownership” from the general prohibition against using loan proceeds to pay an associate of the business.13 CFR 120.150, What are SBA’s lending criteria?
- The Final Rule adds language consistent with long-standing policy that a loan applicant (including any operating company) “must be creditworthy”. However, the detailed list of factors to be considered when determining whether a loan applicant is creditworthy is deleted. These factors included:
- Character, reputation, and credit history of the applicant (and the Operating Company, if applicable), its Associates, and guarantors;
- Experience and depth of management;
- Strength of the business;
- Past earnings, projected cash flow, and future prospects;
- Ability to repay the loan with earnings from the business;
- Sufficient invested equity to operate on a sound financial basis;
- Potential for long-term success;
- Nature and value of collateral (although inadequate collateral will not be the sole reason for denial of a loan request); and
- The effect of any affiliates may have on the ultimate repayment ability of the applicant.
- As a substitute for the existing factors, SBA added new language stating that “Lenders and CDCs must use appropriate and prudent generally acceptable commercial credit analysis process and procedures consistent with those used for their similarly-sized non-SBA guaranteed commercial loans”.[The supplementary information states that SBA-supervised lenders and CDCs that do not make non-SBA guaranteed commercial loans will underwrite their SBA loans in accordance with the credit policies, including credit scoring models, approved by SBA as part of their initial approval for SBA participation and/or during lender oversight processes.]
- SBA also added language permitting lenders, CDCs and SBA to use a business credit scoring model.[The supplementary information states that SBA will provide guidance regarding “the maximum loan sizes that may be underwriting using credit scoring and what other credit factors must be addressed in addition to documenting a satisfactory credit score.]
- Finally, SBA added language stating: “When approving direct or guaranteed loans, Lenders, CDCs, and SBA may consider (as applicable) the following criteria: credit score or credit history of the applicant (and the Operating Company, if applicable), its Associates and any guarantors; the earnings or cashflow of applicant; or where applicable any equity or collateral of the applicant”.
13 CFR 120.160, Loan Conditions
- SBA modified its hazard insurance requirements to state that such insurance will only be required for loans over $500,000. No differentiation is made between hazard insurance requirements for real property and that required for personal property. This represents an increase from the $150,000 threshold included in the Proposed Rule.
[The supplementary information in the Final Rule states that, for loans of $500,000 and under, SBA will include guidance in the Loan Program Requirements stating that “SBA Lenders must follow the hazard insurance policies and procedures they have established and implemented for their similarly sized, non-SBA guaranteed commercial loans”.]
13 CFR 120.193, Reconsideration after denial
- SBA revised the regulations to allow final reconsideration decisions regarding loan denials or loan modification requests to be made either by the Director, Office of Financial Assistance (as currently allowed), or by the Director’s designee(s).
- SBA also amended this section to add new language allowing the SBA Administrator discretion to review a reconsideration request and make the final Agency decision with use of such authority not giving rise to any additional appeal rights not otherwise specified in regulation.
13 CFR 121, Small Business Size Regulations
13 CFR 121.301, What size standards and affiliation principals are applicable to financial assistance programs? [There were only minor language changes in this section between the Proposed Rule and the Final Rule.]
- SBA added a new introductory paragraph which states:“The Small Business Act defines a small business concern as one which is independently owned and operated, and which is not dominant in its field of operation. SBA interprets this statutory definition to require, in certain circumstances, the inclusion of other entities (“Affiliates”) owned by the applicant or an owner of the applicant in determining the size of the applicant”.
- SBA also revised 13 CFR 121.301 (f) to “specifically remove the principle of control of one entity over another as a separate basis for finding affiliation”.
- In addition, SBA significantly rewrote the basis under which affiliation will be found based on ownership, including the thresholds of ownership at which SBA considers an applicant to be affiliated with another business or with an individual, and that arising under stock options, etc.
- SBA removed all other affiliation criteria previously found in 13 CFR 121.301(f), including: affiliation based on management, affiliation based on identity of interest, affiliation based on franchise or license agreements.
[According to the supplementary information, as of the effective date of the Final Rule, SBA will no longer publish its Franchise Directory. However, lenders will continue to be required to “examine Franchised businesses for affiliation based on ownership” and will continue to be responsible for ensuring that all applicants meet all Loan Program Requirements including, but not limited to, obtaining proper lien positions on collateral, and ensuring the applicant does not have discriminatory hiring practices. While the Proposed Rule also stated that SBA would continue to collect a franchisor identifier number (currently called Franchise Identifier Code) on each loan, the Final Rule is silent on that requirement. NAGGL assumes that this issue will be addressed in the upcoming revision 6.1 to SOP 50 10.]
