SBA Loan Modification
Shortly after the economic crash of 2007/2008, the SBA loan default rate peaked and a large amount of SBA borrowers were going to their banks for solutions. However, as the small business world was not prepared for the economic recession, the SBA and lending banks were not prepared for the fallout that would occur regarding SBA loans. Because of this, many lenders went into defense-mode by simply liquidating defaulted SBA borrowers, and quickly, in order to protect their SBA guaranty. Modifications and forbearances became a thing of the past, a myth. The banks and the SBA quickly became inundated with liquidation requests and offer in compromise proposals, and most gave up on any other alternatives.
However, in recent years we have seen some economic improvement. With this has come an improvement in the SBA loan default rate. Slowly as the chaos from the recession melted away, lenders began revisiting the idea of loan forbearances and modifications as a way to reduce their default rate and failure rate and as a way to avoid expensive, lengthy, litigious liquidation procedures. A qualifying business can qualify has several options available that include re amortization, removal of fees in interests, applying past due payments to a balloon payment due at maturity, and periods of complete payment forbearances.
While this is excellent news for the small business community, this process is still very difficult to qualify for. A qualifying business must meet a very specific set of qualifying circumstances which include:
1. Recovery value of the loan is less than face value: In order for a lender to consider modifying the terms of an SBA note, the recovery value of the loan must be less than the face value of a loan. In other words, the bank must see a financial incentive in modifying the loan and waiting to get paid over time versus forcefully collecting against the borrower and guarantor. The recovery value is the forced liquidated value of the business and all guarantors. If the business and guarantor combined have enough available assets to pay off the loan balance, a lender will likely opt to liquidate over modification.
2. The business must show an ability to repay the note with reasonable interest within 5-7 years: If the bank and SBA are going to modify a loan, the modification goes through a similar process as a loan origination. The new proposed repayment schedule must be underwritten by the bank and they must believe in the ability of the business to perform on the new agreement. The ideal financials will show an inability to pay the loans per the original loan agreements but an operational ability to have enough cash flow to service a full repayment within 5-7 years (the typical amount for a re-amortization). Accurate current financials accompanied by financial projections are instrumental in successfully completing a modification.
3. No history of habitual default: SBA modifications are typically only available to first-time defaulted borrowers. If the business has a history of default, lenders will likely discredit any proposal for a modification and elect for liquidation instead.
4. No imminent threat of liquidation from other creditors: If a business is threatened to be liquidated or interrupted by other creditors such as taxing authorities, franchises, landlords, business partners, etc., they will not be willing to modify the terms of an SBA loan. A bank must be sure that the business operations is not in jeopardy and can therefore honor the new agreement. They also must be assured that their collateral base for the loan is protected from the actions of other creditors or stake holders.
If these conditions are met a SBA loan modification is possible. Currently we see these modifications happening most frequently at the larger financial institutions and banks. However, this process has been trickling down and is now beginning at the local bank level as well. Modifications are a great alternative for the right borrowers and guarantors. If done correctly, they removes the conditions of default, gives the business the cash flow relieve it needs, and assures the bank does not lose it’s SBA guaranty, while being paid in full.
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