SBA Issues Final Rules for Business Lending Programs

SBA released a final regulation to streamline and modernize 7(a) and 504 loan program regulations regarding partial changes of ownership, lending criteria, hazard insurance requirements, reconsiderations and affiliation standards. In releasing the regulation, SBA observed the need to modernize these programs to incorporate successful components of COVID era programs such as the Paycheck Protection Program (PPP) and COVID EIDL. The changes to affiliation standards will also apply to the Microloan Program, Intermediary Lending Pilot Program, Surety Bond Guarantee Program, and the Disaster Loan programs. Details on the changes are below. SBA released a proposed rule on October 26, 2022 and received 146 comments. From the proposed rule to the final rule, SBA only made changes to Section 120.160, where they increased the threshold from $150,000 in the proposed regulation, to $500,000 in the final regulation. The final regulation is effective on May 11, 2023.

Section 120.150 – SBA’s Lending Criteria

  • Requires lenders and CDCs to use generally acceptable commercial credit analysis processes and procedures consistent with those used for their similarly sized, non-SBA guaranteed commercial loans.
    • This requires lenders and CDCs to underwrite SBA loans in the same way they underwrite their similarly sized, non-SBA-guaranteed commercial loans.
  • Allows lenders and CDCs to use a business credit scoring model for credit underwriting. The use of credit scoring models will not replace the requirement for lenders and CDCs to comply with other loan program requirements.
    • SBA believes that allowing lenders and CDCs to use credit scoring models for credit underwriting will result in more lenders making smaller loans because the costs will decrease.
  • Revises the factors used to determine an applicant’s eligibility to include:
    • (a) The credit score or credit history of the applicant (and the operating company, if applicable), its associates and any guarantors; 
    • (b) The earnings or cashflow of the applicant; or 
    • (c) Where applicable, any equity or collateral of the applicant. 
  • Replaces the requirement to consider character and reputation with “credit history”
    • The lending industry commonly uses the terms character and credit history interchangeably. The term credit history has a clearer meaning and reputation is difficult to define and apply as a component of loan underwriting and credit review.

Section 120.160 – Loan Conditions

  • Amends the hazard insurance criteria requirement to apply only to 7(a) and 504 loans above $500,000.
  • Current regulation requires hazard insurance for all 7(a) and 504 loans and does not distinguish this requirement by loan size.
  • SBA will provide guidance on the Loan Program requirements for loans of $500,000 or under 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.

Section 120.193 – Reconsideration After Denial

  • Currently, only the Director of the Office of Financial Assistance can make the final decision on reconsidering a loan application when denied. 
  • The SBA now requires that the Director be able to delegate decision-making authority to designee(s) to increase efficiency. 
    • For 7(a) loans, the 7(a) Loan Policy Chief will be among the appointed designees.
    • For the 504 loans, the 504 Loan Policy Chief will be among the appointed designees.
  • The SBA Administrator will have the authority to override the decisions of the Director and/or the designees. 

Section 120.202 – Restrictions on Loans for Changes of Ownership

  • Allows borrowers to use 7(a) loan funds to finance a partial or full change in business ownership. A borrower can also purchase the partial or entire interests of multiple owners.
  • Current regulation restricts borrowers from using loan proceeds to purchase a portion of a business.
  • This regulation will not change SBA’s current rules on Employee Stock Ownership Plans (ESOP) lending. SBA will continue to facilitate employee ownership through ESOPs or other related trusts by providing 7(a) loan funds to purchase a controlling interest.

Section 121.301 – What Size Standards and Affiliation Principles are Applicable to Financial Assistance Programs?

  • These revisions will also apply to the Microloan, Intermediary Lending Pilot, Surety Bond Guarantee, and Disaster (excluding the COVID-19 EIDL) Loan Programs.
  • SBA revised the affiliation regulations to simplify program requirements, streamline the application process for SBA’s programs, and facilitate the review of applications. Revisions include:
    • Removing the principle of control of one entity over another as a separate basis for finding affiliation.
    • Adding an introductory paragraph to include the definition of a small business as “one which is independently owned and operated, and which is not dominant in its field of operation.” This definition includes, in certain circumstances, affiliates owned by the applicant or an owner of the applicant in determining the size of the applicant.
    • Revising “ownership,” to remove the principle of control of one entity over another when determining affiliation. SBA is also expanding the definition of “ownership” to clarify the instances that SBA considers an applicant to be affiliated with an individual or another business.
    • Removing the paragraph “affiliation based on identity of interest” which requires close relatives to provide multiple years’ worth of financial statements for review by a lender and by SBA when the close relative is not a principal of the applicant business.
    • Removing paragraph “affiliation based on franchise and license agreements” because it is no longer applicable. 

Moratorium Rescission and Removal of the Requirement for a Loan Authorization

The SBA issued a final regulation on April 12 that lifts the moratorium on licensing new Small Business Lending Companies (SBLCs) and adds a new type of mission-based institution called a Community Advantage (CA) SBLC. The SBA issued proposed regulation on November 7, 2022, and received 169 comments. Of note, SBA is changing the name of Mission-Based SBLCs to “Community Advantage SBLCs.” The regulation is effective on May 12, 2023. SBA plans to issue notices in the Federal Register with information on the SBLC license application processes.

SBA’s goal in adding CA SBLC’s is to reach underbanked communities. The regulation will also remove the requirement for a Loan Authorization in the 7(a) and 504 loan programs. In 1982, SBA repealed its authority to approve additional SBLCs as participating lenders. Since then, the number of SBLC licenses has remained at 14. To become an SBLC under current regulations, an entity must acquire one of the existing 14 SBLC licenses from an entity that is willing to sell its SBLC license and exit the 7(a) loan program.

Like regular SBLCs, SBA will license CA SBLCs for the sole purpose of making 7(a) loans. When SBA authorizes an additional CA SBLC license to a CA lender, the CA lender will transition from making 7(a) loans in a temporary pilot program to making 7(a) loans under a permanent license in the 7(a) loan program. Adding CA SBLCs to the possible types of 7(a) lenders will also allow CA lenders an opportunity to apply to participate in the 7(a) loan program as a CA SBLC while continuing to meet the needs of underserved communities.

CAMEO wrote a letter asking the SBA to put guardrails on the companies they let in and suggested they should be signers of the Small Business Borrower’s Bill of Rights, but that suggestion wasn’t taken.

Section 120.470 – What are SBA’s additional requirements for SBLCs?

SBA is removing the word “only” to clarify that SBLCs, and CA SBLCs may participate in other lines of business in addition to 7(a) lending or making loans to Intermediaries.

SBA received multiple comments regarding the costs that lending entities may encounter when they become CA SBLCs. SBA agrees with these concerns and will revise the requirement for fidelity insurance. The current requirement for fidelity insurance is that an SBLC must maintain a Brokers Blanket Bond or Finance Companies Blanket Bond or such other form of coverage as SBA may approve, in a minimum amount of $2 million executed by a surety holding a certificate of authority from the Secretary of the Treasury. SBA determined this requirement may be overly burdensome
for CA SBLCs and will provide an exception to state that SBA’s Administrator, with SBA’s Associate Administrator for the Office of Capital Access (AA OCA) or their designees will determine the appropriate coverage levels for CA SBLCs.

Section 120.471 – What are the minimum capital requirements for SBLCs?

SBA received comments that SBA should consider requiring a minimum loan loss reserve requirement for CA SBLCs. SBA agrees with these comments and will require CA SBLCs to maintain a loan loss reserve account as determined by the Administrator, in consultation with the AA OCA or their designees.