DEBT REFINANCE APPLICATIONS. How to Avoid Screenouts 2010 NADCO
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1 DEBT REFINANCE APPLICATIONS How to Avoid Screenouts 2010 NADCO
2 Topics to be Covered Why revisit debt refinancing Amount of debt that can be refinanced Debt refinancing requirements Documentation to be submitted to SLPC Lien Instruments Promissory Notes Transcripts of account Substantial Benefit Worksheet 2
3 Why Revisit Debt Refinance? 3 Even though debt refinancing has been part of the 504 Loan Program for more than a year, according to our partners at the SLPC, almost all 504 applications involving debt refinancing are being screened out This causes delays in processing and frustration for all parties involved and is easily remedied with a proper understanding of what is required
4 Debt Refinancing 504 Projects currently may include a limited amount of debt refinancing as an eligible 504 Project Cost The 504 Project must involve expansion of a small business Expansion is broadly defined to include any Project that involves the acquisition, construction or improvement of land, building or equipment for use by the small business 4
5 Amount of Debt That Can Be Refinanced 5 Any amount of existing debt that does not exceed 50% of the cost of expansion may be refinanced The cost of expansion is all Project Costs other than the debt being refinanced, i.e., the new money being borrowed for: Purchase of land or land & building Construction/remodeling Purchase/install equipment or fixtures Professional Fees Other Expenses
6 Amount of Debt That Can Be Refinanced cont. 6 Land/Building Equity 351,667 Building Construction 2,000,000 Debt Refinance 1,055,000 *** Professional Fees 30,000 Interest/Fees on Interim Loan 80,000 Debt in Excess of 50% 212,000 TOTAL PROJECT COST $3,728,667 ***The eligible refinance amount is 50% of $2,110,000. Land/Bldg equity and excess Consolidation of Pre- Existing Debt do not apply towards Expansion Costs.
7 Debt Refinancing Requirements All Requirements Must Be Met (1) The debt being refinanced was used for 504-eligible fixed assets: to acquire land, including a building, to construct a building or to purchase equipment/fixtures (2) The existing debt was incurred for the benefit of the small business (3) The existing debt is collateralized by the fixed assets 7
8 Debt Refinancing Requirements All Requirements Must Be Met cont. 8 (4) Borrower has been current on all payments on the existing debt for not less than 1 year (5) Refinancing will provide a substantial benefit to Borrower (6) Refinancing will provide better terms or rate of interest than the existing debt (7) The 504 Loan proceeds will be used only for cost of expansion and refinancing eligible existing debt
9 Debt Refinancing Requirements All Requirements Must Be Met cont. (8) The 504 Loan proceeds are not used to refinance debt owed to: An Associate of the 504 Loan applicant An SBIC Any creditor in a position to sustain a loss causing a shift to SBA of all or part of a potential loss from the existing debt 9
10 Documenting Debt Refinancing Requirements at Application 10 For non-pclp Loans, CDC must include a conclusion in its credit memo that the proposed debt refinancing meets all the requirements, together with supporting analysis and documentation For PCLP loans, PCLP CDC must address the debt refinancing requirements in the Eligibility Information Required for PCLP Submission (SBA Form 2234, Part C) sent to SBA, and must maintain the analysis and documentation in its file
11 Recommendation! A checklist outlining each of the components for the debt refinance request how the requirements are being met - should be included as a cover sheet in Exhibit 24 of the 504 loan application A sample of a checklist is included in your webinar materials, so let s look at it now 11
12 (1) Existing Debt Used To Purchase 504-Eligible Assets The existing debt must have been used to acquire 504-eligible fixed assets The existing debt does not need to be for assets at the same location or for the same type of property as the 504 Project as long as the business operation at the other location has the same NAICS code as the business operation at the Project location 12
13 (1) Existing Debt Used To Purchase 504-Eligible Assets cont. 13 Existing debt may include instruments that will result in transferring ownership of the property to the small business, including: Land sales contracts Contracts for deed Capital leases The purchase of land under an operating lease is eligible for 504 financing, but the operating lease itself is not eligible for debt refinancing
14 (1) Existing Debt Used To Purchase 504-Eligible Assets cont. An existing debt is disqualified from refinancing if it was used for working capital or any other purpose not eligible for 504 financing BUT where a portion of the existing debt was used for 504-eligible fixed assets, that portion of the existing debt is eligible for refinancing 14
15 Documenting Proceeds Were Used To Acquire Eligible Assets 15 As part of Exhibit 24, provide the SLPC: For real estate with: Copy of the recorded deed or land sale contract, contract for deed or capital lease showing the applicant s interest in the real estate Copy of recorded lien instrument (e.g., mortgage or deed of trust) for the debt being refinanced that shows the original debt was for eligible real estate
16 Documenting Proceeds Were Used To Acquire Eligible Assets cont. For equipment and fixtures with: Copy of the security agreement for the debt being refinanced that shows that the original debt was for eligible equipment and fixtures For fixtures, this might be included in the real estate mortgage or deed of trust Copy of filed UCC-1/UCC-3 financing statements and fixture filings 16
17 Documenting Proceeds Were Used To Acquire Eligible Assets cont. 17 What does not qualify as a lien instrument is: Purchase and sale contract Settlement statement Business, Construction or other Loan Agreement Commitment letter or letter of intent Promissory note more about notes in a moment
18 Documenting Proceeds Were Used To Acquire Eligible Assets cont. 18 Where the debt being refinanced was used for both eligible and ineligible purposes, provide evidence of what portion of the debt was for eligible 504 fixed assets and related costs Preferably this will be a statement or disbursement sheet from the lender whose debt is being refinanced breaking down its use of proceeds into eligible and ineligible categories or a settlement statement
19 Don t Forget The Promissory Note(s) Exhibit 24 also must include a copy(ies) of the signed promissory note(s) evidencing the debt being refinanced The note(s) will show to whom the loan was made so that CDC can verify that the existing debt was incurred for the benefit of the small business 19
20 Don t Forget The Promissory Note(s) cont. 20 The entire history, i.e., the genealogy, of the debt being refinanced must be provided!! For example, if the original note has been refinanced previously or modified in some other way, then CDC must include not only the current note, but all prior notes and change in terms or modifications back to the original note SLPC will examine all notes and change in terms in the debt s genealogy
21 Same Institution Debt Same institution debt is any debt of the CDC and/or Third Party Lender who is financing the new Project, and/or affiliates of either Any debt can mean 504 Loans, 7(a) Loans or other loans made by CDC or Third Party Lender or an affiliate of either Same institution debt may be refinanced, but only SBA may approve the refinancing and not PCLP-CDCs This is to avoid any conflict of interest or appearance of a conflict of interest 21
22 Same Institution Debt cont. The lender(s) of the debt to be refinanced must agree to release the lien(s) on the 504 eligible assets so that the 504 Loan will have the 2nd lien position on those assets It is recommended that a letter from the lender(s) agreeing to release the lien(s) be included in Exhibit 24 22
23 (2) Existing Debt Was Incurred For The Small Business The small business for which existing debt is refinanced must be the same small business for which any new Project costs are incurred The existing debt may be owed by an Operating Company or an Eligible Passive Company or both The existing debt may consist of one or more loans 23
24 (2) Existing Debt Was Incurred For The Small Business cont. Both existing 504 Loans and 7(a) Loans are existing debt which may be refinanced An existing 504 Loan may be refinanced if it meets all the requirements for debt refinancing and whether the existing 504 Loan was made by the same or a different CDC 24
25 (2) Existing Debt Was Incurred For The Small Business cont. An existing 7(a) Loan may be refinanced in whole or in part only if: CDC provides verification that the current 7(a) lender is unwilling or unable to modify the current payment schedule For example, the current 7(a) lender cannot modify the current payment schedule because a secondary market investor will not agree to modified terms 25
26 (2) Existing Debt Was Incurred For The Small Business cont. 26 CDC does not have to get the current 7(a) lender s consent to the debt refinancing; CDC just has to provide verification that the current 7(a) lender is unable or unwilling to modify its current payment schedule There are various types of acceptable verification, including, but not limited to, a letter from the current 7(a) lender that it will not modify or a copy of a letter or other written response from the 7(a) lender declining or refusing Borrower s request to modify
27 (2) Existing Debt Was Incurred For The Small Business cont. Question: In the current economy, many lenders who originated 7(a) loans are gone and it may be difficult to find the lender who now holds the 7(a) note or get verification that lender will not modify. How does the CDC proceed if the originating 7(a) lender is no longer in operation? Answer: If the originating 7(a) lender is gone, SBA can identify whether SBA or another lender is the current holder of the 7(a) promissory note; CDC or Borrower must then follow up with that lender 27
28 (2) Existing Debt Was Incurred For The Small Business cont. If the Third Party Lender or a CDC affiliate is the 7(a) lender, then the 7(a) Loan is eligible for 504 debt refinancing only if the 7(a) lender is unable to modify the existing terms because a secondary market investor will not agree to modified terms 28
29 Seller Debt Special Case 29 An existing Seller note may be refinanced Instruments resulting in transfer of ownership of the Property to the small business are eligible for refinancing If the Seller is a private individual, then CDC will need to work with the Seller, prior to application, to obtain a satisfactory note and transcript of account If a seller note does not exist, then the debt cannot be refinanced
30 (3) Existing Debt Is Collateralized By Fixed Assets 30 The 504-eligible fixed assets collateralizing the existing debt to be refinanced must also collateralize the 504 Loan unless SBA [the SLPC] approves a waiver due to extraordinary circumstances PCLP CDCs may not use their delegated authority to approve a 504 Loan requiring this waiver The lender of the existing debt must release, subordinate or assign its lien on the 504-eligible fixed assets so that Third Party Lender and/or SBA on the 504 Loan will have the same lien position on the collateral previously held by the lender whose debt is being refinanced
31 (3) Existing Debt Is Collateralized By Fixed Assets cont. 31 If the assets securing the existing debt are at a different location than the Project Property, then separate appraisal and environmental reports are required if the appraisal and environmental requirements of SOP 50-10(5) are applicable The SOP appraisal requirements apply to commercial real estate or equipment The SOP environmental requirements apply to commercial real estate
32 (3) Existing Debt Is Collateralized By Fixed Assets cont. 32 In preparing the Authorization, the 504- eligible fixed assets collateralizing the existing debt are considered Project collateral because the Refinanced Debt is a Project Cost Both the expansion property and any 504-eligible fixed assets securing the existing debt to be refinanced, but at a different location, are in Part A. PROJECT TO BE FINANCED Paragraph 1. Project Property
33 (4) Borrower Has Been Current On The Existing Debt Borrower must have been current on all payments due on the existing debt for not less than 1 year preceding the date of refinancing (or for the time the existing debt has been open if less than 1 year) Date of refinancing'' means the date that the 504 Loan is approved by SBA For a PCLP Loan, that is the date the 504 PCL Loan Number is issued 33
34 (4) Borrower Has Been Current On The Existing Debt cont. 34 CDC must submit a transcript of account or similar documentation containing detailed payment history from the lender whose debt is being refinanced reflecting that the existing debt has been current For a 7(a) Loan or 504 Loan is being refinanced, a transcript of account from Colson Services Corp. can be used Current means not more than 30 days past due
35 (4) Borrower Has Been Current On The Existing Debt cont. An acceptable transcript of account includes: Date payment is due Date payment is made/posted Amount of payment Remaining/current balance Original balance Any late fees 35
36 (4) Borrower Has Been Current On The Existing Debt cont. If late fees have been incurred, CDC must confirm that no payments were more than 30 days past due It is recommended that a letter from the lender verifying that the debt has been paid as agreed be included in Exhibit 24 36
37 (4) Borrower Has Been Current On The Existing Debt cont. Any unremedied delinquency on the existing debt after 504 Loan approval must be reported to SBA as an adverse change Typically the existing debt is refinanced with the interim financing and this occurs shortly after 504 Loan approval when the Interim Loan closes and funds Consequently, it then would be an unremedied adverse change on the Interim Loan CDC must delay closing and submitting the 504 Loan for debenture funding until that delinquency is remedied or CDC must cancel the Authorization 37
38 (4) Borrower Has Been Current On The Existing Debt cont. A loan on deferment is not considered current and is not eligible for refinancing But if Borrower was on deferment and has been current for at least 1 year on the catch up plan, then the existing debt is eligible for refinancing 38
39 (5) Refinancing Will Provide A Substantial Benefit to Borrower 39 The refinancing must provide a substantial benefit to the applicant Substantial benefit'' means that the portion of the new installment amount(s) on the Third Party Loan and 504 Loan attributable to the debt being refinanced must be at least 10% less than the existing installment amount(s) Exceptions can only be granted by SBA, not by PCLP-CDCs under delegated authority
40 (5) Refinancing Will Provide A Substantial Benefit to Borrower cont. 40 Prepayment penalties, financing fees and other financing costs required by the existing debt instruments may be added to the amount being refinanced to calculate the percentage reduction in the new installment amount(s) For a 7(a) Loan or 504 Loan is being refinanced, a prepayment estimate from Colson Services Corp. may be used to establish the 10% reduction Refinancing a balloon payment is deemed to be a substantial benefit
41 (5) Refinancing Will Provide A Substantial Benefit to Borrower cont. 41 The substantial benefit of at least 10% is calculated at the time of 504 Loan approval In calculating the new installment amount(s) on the Third Party Loan and 504 Loan attributable to the debt being refinanced, CDC uses the interest rate committed on the Third Party Loan and projected on the 504 Loan If the Third Party Loan interest rate is based on an index or margin (e.g., Prime Rate), then CDC uses that index or margin at the time of application For the 504 interest rate, CDC uses the most recent debenture funding rates
42 (5) Refinancing Will Provide A Substantial Benefit to Borrower cont. 42 Failure to include a substantial benefit analysis in the application = screen out It is strongly recommended that CDCs use the template provided by SLPC to calculate the substantial benefit This can be found on the NADCO website and at loans/ Go to drop down menu Refinancing See Click Here to Download a Refinance Worksheet
43 43 Substantial Benefit Worksheet
44 (6) Refinancing Will Provide Better Terms Or Rate Of Interest The refinancing under 504 will provide better terms or rate of interest than the existing debt on the date of refinancing Again date of refinancing'' means the date that the 504 Loan is approved by SBA For a PCLP Loan, that is the date the 504 PCL Loan Number is issued 44
45 (6) Refinancing Will Provide Better Terms Or Rate Of Interest cont. Better terms or rate of interest may include, but are not limited to: Longer maturity, but always commensurate with the useful life of the fixed assets A lower interest rate committed on the Third Party Loan or projected on the 504 Loan Improved collateral conditions Less restrictive loan covenants 45
46 (7) Use Of 504 Loan Proceeds The Project financing (Third Party Loan, Interim Loan, 504 Loan and Borrower contribution) can be used only for: Refinancing eligible existing debt Costs of expansion relating to the Project 46
47 (7) Use Of 504 Loan Proceeds cont. 47 Costs essential to the refinancing, such as prepayment penalties, financing fees or other refinancing costs required by the original terms of the existing debt instrument, may be included in the debt refinance portion of 504 Project Costs Refinancing costs, however, do not have to be included Refinancing costs also do not mean the new Third Party Loan and new 504 Loan prepayment penalties and financing fees
48 (8) Prohibited Refinance Debt 504 Loan proceeds cannot used to refinance debt owed to: An Associate of the 504 Loan applicant An SBIC Any creditor in a position to sustain a loss causing a shift to SBA of all or part of a potential loss from the existing debt 48
49 (8) Prohibited Refinance Debt cont. 49 A creditor in a position to sustain a loss would be any type of adverse condition involving the existing debt that puts the small business at risk and possibly unable to continue to pay the debt Examples include: Borrower has filed bankruptcy, but is paying the existing debt Borrower is current on the existing debt, but the business is no longer in operation The lender for the existing debt is aware that Borrower is in arrears on other loans with that lending institution The lender for the existing debt is aware of other adverse or deem-at-risk factors
50 Project In or Outside of CDC s Area of Operations 50 Whether the new Project is within CDC s Area of Operations is based on the assets newly acquired for the small business and not on assets securing the debt being refinanced If the assets being refinanced or any collateral securing the existing debt are outside CDC s Area of Operations, CDC must establish that it is capable of closing and servicing the 504 Loan and monitoring the collateral Non-PCLP CDCs must submit evidence to the SLPC for approval that the CDC is capable of closing and servicing the 504 Loan and monitoring the collateral PCLP CDCs must document the file with evidence of their capability
51 Borrower Equity Contribution 51 Equity in land and/or building but not equipment- that is being refinanced may be included as Borrower s contribution as set forth under existing SBA policy This includes equity in the Project Property or in the other assets collateralizing the existing debt and now securing the 504 Loan There is no change in how the Borrower s contribution is calculated/confirmed for Projects with debt refinancing
52 Excess Debt To Be Refinanced 52 If the existing debt to be refinanced was used for 504-eligible fixed assets and is existing debt on the Project Property (that is, already secured by the Project Property), then that portion of the existing debt which does not exceed 50% of the cost of expansion can be included in the 504 Project Costs and the excess can be consolidated into the Third Party Loan Debt refinancing does not change 13 C.F.R. Section on consolidation of pre-existing debt
53 Excess Debt To Be Refinanced cont. Alternatively, and as long as the existing debt is debt on the Project Property, the Third Party Lender can do all the debt refinancing as pre-existing consolidated debt The concept behind adding debt refinancing to the 504 Project is that the Third Party Lender, CDC and Borrower all contribute to the refinancing in the appropriate percentages 53
54 Excess Debt To Be Refinanced cont. 54 If the existing debt to be refinanced is not existing debt on the expansion Project Property, then only that portion of the existing debt that does not exceed 50% of the cost of expansion may be refinanced in the 504 Project The excess debt can be refinanced by the Third Party Lender or another lender, but only in a junior lien position to SBA on the fixed assets now collateralizing the 504 Loan
55 Appraisals and Debt Refinancing The appraisals on the Project Property and any assets at a different location must support the Total Project Costs: the new cost of expansion and the existing debt being refinanced 55
56 Examples of Debt Refinancing Let s look at some examples of 504 Loans with debt refinancing 56
57 Q&A with SBA Presenter: Zola Finch, Director of Finance Programs, RMI; NADCO Past Chair Richard Jones, SLPC 504 Finance Chief David Miller, SLPC Senior Loan Officer Dennis Stytz, SLPC Loan Officer Mike Vanchiere, Mountain West Small Business Finance & NADCO Packaging Instructor Mindy Murray, RMI, NADCO Packaging Instructor 57
58 Special Thanks NADCO would like to thank the following persons from SBA who assisted in preparing this Webinar: Richard Jones, SLPC 504 Finance Chief David Miller, SLPC Senior Loan Officer Dennis Stytz, SLPC Loan Officer 58
59 Conclusion Thank you for your participation in this Webinar If you have any additional questions on debt refinancing, please send them to Please complete and submit your evaluation form promptly so that NADCO can forward your certificate of attendance 59
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