Ask the Experts: 504 Q & A

Q – How is adequate collateral determined under the 504 loan program? Must a guarantor pledge a residence if it has 20% equity in the home?

A – Adequacy of collateral is made on a case-by-case determination and is part of the credit evaluation of every application. Collateral requirements for 504 loans are less stringent than for 7(a) because the purpose of 504 is to foster economic development. It is expected that 504 loan recipients will provide a continuing economic development impact, and in the vast majority of cases, the 504 project property alone is sufficient to fully secure the 504 loan.

Thus, there is no mandatory requirement for guarantors to pledge personal residences under the 504 loan program. In fact, the following is considered when determining adequate collateral:

The project collateral is sufficient to protect the Government's interests if the applicant can satisfy all of the following factors, (listed in order of importance).

(1) The borrower has a strong, consistent cash flow that is more than adequate to support the new debt;

(2) Has proven management;

(3) Is an existing business; and

(4) The project is a logical extension of the applicant's current operations.

If all four factors are present, no additional collateral and/or borrower's contribution is required.

Q – What happens if the appraisal comes in low and one or more of the above factors are not met?

A – Additional analysis is conducted and based upon the following eight steps to determine if additional collateral or other alternatives should be required.

(1) The analyst must look at the relative importance of the factor(s) missing and compare them to the relative strengths of the factors that are present and their ability to overcome the weakness of the missing factor(s). (Normally, for existing businesses weaknesses in ability to show repayment cannot be overcome by strengths in the other factors).

(2) If the analyst, with SBA concurrence, determines that the relative strength of the factors present to overcome the weaknesses of the factor(s) missing, again no additional collateral and/or contribution is required.

(3) If the analyst cannot overcome the weaknesses of the missing factor(s) from an analysis of the applicant, other information may be considered to overcome the weaknesses. This includes the degree of importance of the project's impact on the local economy; the CDC's performance including default and recovery rates on its 504 loans; SBA's experience with the type of business (SIC code, 10-year history); and the equivalent franchise history if appropriate.

(4) If the analyst still cannot overcome the weaknesses of the missing factor(s), calculate the likely recoverable value of the project collateral in a default to determine the amount of the shortfall. Then the availability of additional collateral and/or borrower's contribution must be determined.

CAUTION: The SBA urges lenders, including CDCs, not to encumber assets or require additional contribution that the borrower needs to sustain ongoing operations.

(5) After determining what additional collateral and/or contribution is available, a risk analysis is required to determine how much additional collateral or injection is needed to offset the risk. The additional collateral does not, in all cases, have to fully secure the loan in a default situation.

(6) If the borrower has the additional collateral and/or contribution that the analyst, with SBA concurrence, has determined to be necessary, the loan may be approved with a requirement for the necessary additional collateral and/or contribution.

(7) If the borrower is unwilling to pledge available collateral (and/or provide an increased contribution) which the analyst and the SBA has determined to be necessary, the loan must be declined.

(8) If after going through these steps it is determined that insufficient collateral is available to offset the repayment risk, the loan must be declined.

Q – Will the CDC Analyst and the SBA work with the lender aggressively to make sure every attempt is made before the loan is declined?

A – Absolutely. Because the main purpose of the SBA 504 loan program is economic development, FFCFC personnel work aggressively with other Economic Development Organizations and Small Business Development Centers to make sure that all of the economic impact of the small business is considered when it has been determined that there is a collateral shortfall. FFCFC personnel also work with their partner lenders to explore all collateral options to make sure that assets are not encumbered that would affect the small businesses ability to operate.

For deal specific questions, please feel free to contact your local FFCFC’s personnel for assistance.

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