What are the Effects of the SBA’s Elimination of the “Personal Resources Test” on Small Business Borrowing?
The Personal Resources Test for SBA loans set forth a formula requiring any 20%-or-greater owners of businesses to use a portion of their personal resources to reduce the SBA’s share of the financing requested. The formula, based upon loan size, required the owners to inject capital to the extent of their liquid assets in excess of a specified multiple of the financing package (13 CFR 120.102).
On March 21, 2014, the SBA eliminated the Personal Resources Test by removing section 120.102 from the Code of Federal Regulations. This would seem to have the effect of not requiring small business owners and 20% investors to inject more equity capital into a business, therefore, attracting borrowers with more personal liquidity to the SBA loan programs. This, in turn, should produce more creditworthy borrowers and increase the probability of success for businesses.
However, there is a potential hazard for lenders arising from SOP 50 10 5(F), Chapter 4, Section II, which deals with collateral requirements for loans over $350,000. Here, the SBA requires that lenders collateralize these loans to the maximum extent possible up to the amount of the loans. There is an apparent contradiction between this section of the SOP and the elimination of the Personal Resources Test. On one hand, borrowers are not required to inject personal assets; on the other, they are required to fully collateralize loans. In the commentary to the new rule, the SBA addressed this issue, but did not definitively provide clarification. They acknowledged that there is a distinction between requiring the use of personal liquid assets to reduce the amount of a loan, and taking these assets as collateral. They stated that “a lender that believes that prudent lending requires that assets either be injected or pledged as collateral would not be prohibited from so requiring.” However, since the above mentioned section of the SOP requires lenders to fully collateralize loans over $350,000, does this imply that, in the SBA’s view, ”prudent lending” requires lenders to take personal liquid assets as collateral?
Perhaps, to protect the guarantee, it would be “prudent” to take the personal liquid assets as collateral so that it is fully collateralized. Unfortunately, this could pose a future problem for the lender. What if the borrower needs to access that collateral for what the lender deems to be a legitimate business purpose and the lender releases it? If the loan later defaults and is no longer fully collateralized will the lender be criticized and the guarantee denied? Remember, the SBA and Inspector General always have the benefit of hindsight when reviewing lenders’ actions. Hopefully, further guidance will be forthcoming.