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More Skin in the Game: The SBA’s Proposal to Reinstate the Personal Liquidity Test

Lending regulations are constantly changing, especially those that apply to SBA backed loan products. Earlier this year the SBA instituted a new version of their Standard Operating Procedures (SOP), which included language referred to as the “Personal Liquidity Test” added as part of the Credit Elsewhere Test. The Personal Liquidity Test suggests looking at all of a borrower’s usable liquid assets. Unfortunately, the language is vague and doesn’t provide much direction as to what exactly should be considered as usable liquid assets.

Below is the passage in question:

The Lender must include in its credit memorandum:  A determination that some or all of the loan is not available from any non-Federal sources, including the liquidity of owners, spouses, guarantors, Associates, and the Applicant. 

The ambiguity of the passage has raised many questions and left much up to interpretation by lenders. As a result, the SBA is considering adding clearer specifications to the test and is soliciting feedback from lenders. The new specifications would impact certain borrowers, particularly high net worth individuals with sizeable stores of liquid assets, and would be determined based on the total loan amount. Below are the new specifications proposed by the SBA:

“(1) Is $350,000 or less, each 20 percent owner of the Applicant must inject any liquid assets that are in excess of one and three-quarter times the total financing package, or $200,000, whichever is greater;

(2) Is between $350,001 and $1,000,000, each 20 percent owner of the Applicant must inject any liquid assets that are in excess of one and one-half times the total financing package, or $1,000,000, whichever is greater;

(3) Exceeds $1,000,000, each 20 percent owner of the Applicant must inject any liquid assets that are in excess of one times the total financing package, or $2,500,000, whichever is greater.”

All indications show that the new language will go into effect. As a result, we here at Salt Creek have already been applying the new guidelines for the Personal Liquidity Rule to our loans. This due diligence ensures that loans in progress can stand up to SBA scrutiny, as well as ensures that we are fulfilling our responsibility to our clients and stakeholders.

It is important to note that the Personal Resource Test is not new. It is a previous rule that was sunset back in 2014 due to concerns that it limited the availability of credit to businesses owned by individuals with considerable liquid assets. However, the Personal Liquidity Rule was reintroduced because the purpose of SBA guaranty loans is to provide access to credit to individuals who wouldn’t qualify for other forms of credit. Generally speaking, borrowers with significant liquid assets could qualify for conventional loans, and thus would not need to leverage SBA programs to secure credit. This is where the term “credit elsewhere” comes from, as business owners with sizeable liquid assets have the ability to secure credit elsewhere. As a result, the higher injection requirement for high net worth borrowers acts as a deterrent, incentivizing those borrowers to consider other programs before committing to an SBA product.

The new rule specifications proposed contain a few minor changes compared to the rule phased out in 2014. Those changes specifically apply to the thresholds for liquid assets compared to the value of the total financing package. Most notably, the new rule will only apply to loans of $350,000 or higher. Previously, the rule applied to loans of $250,000 or more. The liquidity thresholds have also been lowered, which means more borrowers would fall under this rule.

The new rule will maintain the requirement for lenders to consider all of the borrower’s resources, including those of their spouse and minor children. Certain funds, such as college accounts, can be omitted at the discretion of the lender, but all other accounts must be considered, though not necessarily injected. As per existing SBA requirements, this rule will also apply to all owners with 20% or more ownership in the company, regardless of their role in operations.

Overall, the new rule would require high net worth individuals to bring more to the table in order to take advantage of an SBA guaranty. If you have concerns about the proposed rule, contact your Salt Creek Advisor. We will also provide updates as this and other proposed changes develop.