Proposed Rule2022-23167
Affiliation and Lending Criteria for the SBA Business Loan Programs
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
October 26, 2022
Issuing agencies
Small Business Administration
Abstract
The U.S. Small Business Administration (SBA or Agency) is proposing to amend various regulations governing SBA's 7(a) Loan Program and 504 Loan Program, including use of proceeds for partial changes of ownership, lending criteria, loan conditions, reconsiderations, and affiliation standards, to expand access to capital to small businesses and drive economic recovery. The proposed amendments to affiliation standards will also apply to the Microloan Program, Intermediary Lending Pilot Program, Surety Bond Guarantee Program, and the Disaster Loan programs (except for the COVID Economic Injury Disaster Loan (EIDL) Disaster Loan Program).
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<title>Federal Register, Volume 87 Issue 206 (Wednesday, October 26, 2022)</title>
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[Federal Register Volume 87, Number 206 (Wednesday, October 26, 2022)]
[Proposed Rules]
[Pages 64724-64734]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-23167]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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Federal Register / Vol. 87, No. 206 / Wednesday, October 26, 2022 /
Proposed Rules
[[Page 64724]]
SMALL BUSINESS ADMINISTRATION
13 CFR Parts 120 and 121
RIN 3245-AH87
Affiliation and Lending Criteria for the SBA Business Loan
Programs
AGENCY: U.S. Small Business Administration.
ACTION: Proposed rule.
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SUMMARY: The U.S. Small Business Administration (SBA or Agency) is
proposing to amend various regulations governing SBA's 7(a) Loan
Program and 504 Loan Program, including use of proceeds for partial
changes of ownership, lending criteria, loan conditions,
reconsiderations, and affiliation standards, to expand access to
capital to small businesses and drive economic recovery. The proposed
amendments to affiliation standards will also apply to the Microloan
Program, Intermediary Lending Pilot Program, Surety Bond Guarantee
Program, and the Disaster Loan programs (except for the COVID Economic
Injury Disaster Loan (EIDL) Disaster Loan Program).
DATES: SBA must receive comments on this proposed rule on or before
December 27, 2022.
ADDRESSES: You may submit comments, identified by RIN 3245-AH87,
through the Federal eRulemaking Portal: <a href="http://www.regulations.gov">http://www.regulations.gov</a>.
Follow the instructions for submitting comments.
SBA will post all comments on <a href="http://www.regulations.gov">http://www.regulations.gov</a>. If you
wish to submit confidential business information (CBI) as defined in
the User Notice at <a href="http://www.regulations.gov">http://www.regulations.gov</a>, please submit the
information via email to <a href="/cdn-cgi/l/email-protection#501439313e3e317e033531323f223e102332317e373f26"><span class="__cf_email__" data-cfemail="c185a8a0afafa0ef92a4a0a3aeb3af81b2a3a0efa6aeb7">[email protected]</span></a>. Highlight the
information that you consider to be CBI and explain why you believe SBA
should hold this information as confidential. SBA will review the
information and make the final determination whether it will publish
the information.
FOR FURTHER INFORMATION CONTACT: Dianna Seaborn, Director, Office of
Financial Assistance, Office of Capital Access, Small Business
Administration, at (202) 205-3645 or <a href="/cdn-cgi/l/email-protection#b1f5d8d0dfdfd09fe2d4d0d3dec3dff1c2d3d09fd6dec7"><span class="__cf_email__" data-cfemail="85c1ece4ebebe4abd6e0e4e7eaf7ebc5f6e7e4abe2eaf3">[email protected]</span></a>.
SUPPLEMENTARY INFORMATION:
I. Background Information
The mission of SBA is to ``aid, counsel, assist and protect the
interests of small business concerns in order to preserve free
competitive enterprise and to maintain and strengthen the overall
economy of our nation.'' 15 U.S.C. 631(a). SBA accomplishes this
mission, in part, through Capital Access programs that bridge the
financing gap in the private market and help businesses of all sizes to
recover from disasters. 15 U.S.C. 636(a) and (b). SBA has determined
that changing conditions in the American economy, technological
developments, and a constantly evolving small business community
necessitate the need to revise regulations to improve program
efficiency and the customer experience for the 7(a) and 504 Loan
Programs. Additionally, SBA has determined that revisions for similar
purposes to SBA regulations on affiliation determinations should also
apply to the Microloan Program, the Intermediary Lending Pilot Program
(ILP Program), the Surety Bond Guarantee Program (SBG Program), and the
Business Disaster Loan Programs, which consist of Physical Disaster
Business Loans, Economic Injury Disaster Loans, and Military Reservist
Economic Injury Disaster Loans (but do not include COVID EIDL Disaster
Loans).
SBA is proposing to streamline and modernize the 7(a) Loan Program
and 504 Loan Program regulations setting forth use of proceeds
regarding partial changes of ownership, lending criteria, hazard
insurance requirements, and reconsiderations. Specifically, SBA is
revising 13 CFR 120.130 on ``Restrictions on uses of proceeds''; 13 CFR
120.150 on ``What are SBA's lending criteria?''; 13 CFR 120.160 on
``Loan conditions''; 13 CFR 120.193 on ``Reconsideration after
denial''; 13 CFR 120.202 on ``Restrictions on loans for changes of
ownership''.
Historically, SBA has permitted loan proceeds for use only in three
situations involving a change of ownership: (1) A complete change of
ownership where the debt was used to finance a change of ownership of a
business concern with new owner(s) who previously held no interest in
the small business concern acquiring 100 percent of the outstanding
equity ownership in the small business from the selling owner(s), and
the seller(s) completely divest from all ownership interest and
management activities for the small business concern; or (2) A Partner
Buyout, where the small business concern uses the loan to affect a
change of ownership between existing owners and the owners which remain
after the sale is complete held an ownership interest prior to the
sale, and the selling owner(s) completely divest from all ownership
interest and management activities for the small business concern; and
(3) where an Employee Stock Ownership Plan or equivalent trust (ESOP)
purchases a controlling interest (51% or more) in the employer small
business from the current owner(s). Except for where an ESOP purchases
a controlling interest (51% or more) in the employer small business
from the current owner(s), SBA's current regulations do not permit 7(a)
loan proceeds to be used for partial changes of ownership. SBA proposes
to revise restrictions on Borrowers using 7(a) loan proceeds to effect
partial changes of ownership to assist small businesses and expand
pathways to ownership.
SBA believes that streamlining and modernizing regulations on
lending criteria and loan conditions for its 7(a) Loan Program and 504
Loan Program can better position the Agency and participating lenders
to meet the needs of America's small businesses, create jobs, assist
with recovery from the COVID-19 pandemic, and grow the economy, fueling
American entrepreneurship. Further, these proposed changes will enable
SBA to provide capital in the form of 7(a) and 504 loans to more small
businesses.
SBA also proposes to revise the process for reconsideration after
denial of a loan application or loan modification request in its 7(a)
Loan Program and 504 Loan Program to provide the Director, Office of
Financial Assistance, with the authority to delegate decision making to
designees. The proposed revision would also provide that the
Administrator, solely within her discretion, may review these matters
and make the final agency decision on reconsideration. Such
discretionary authority of the
[[Page 64725]]
Administrator would not create additional rights of appeal on the part
of an applicant not otherwise specified in SBA regulations.
Further, SBA proposes to simplify 13 CFR 121.301, which sets forth
the principles for determining affiliation in the 7(a) Loan Program,
504 Loan Program, Microloan Program, ILP Program, SBG Program, and
Business Disaster Loan Programs (except for the COVID EIDL Disaster
Loan Program). Specifically, SBA proposes to remove the provisions on
affiliation arising from management and control, franchise or license
agreements, and identity of interest, and SBA proposes to streamline
affiliation determinations based on ownership. This proposed rule would
redefine affiliation for all these programs, thereby simplifying
affiliation determinations.
The Agency requests comments on all aspects of regulatory revisions
in this proposed rule and on any related issues affecting the 7(a)
Loan, 504 Loan, Microloan, ILP, SBG, and Business Disaster Loan
Programs.
II. Section-by-Section Analysis
Section 120.130--Restrictions on Uses of Proceeds
Current Sec. 120.130, paragraph (g), refers to a restriction in
Sec. 120.202 regarding restrictions on Borrowers from using loan
proceeds to purchase a portion of a business or another owner's
interest in a business. SBA proposes to revise Sec. 120.202, as
described below, to allow use of 7(a) loan proceeds to fund partial
changes of ownership. SBA is proposing to make this change to assist
small businesses and provide a path to ownership for employees.
Therefore, SBA is proposing to revise Sec. 120.130(g) to remove the
reference to Sec. 120.202.
Section 120.150--What are SBA's lending criteria?
Current Sec. 120.150 states that SBA's lending criteria for 7(a)
and 504 loans requires that the applicant (including the Operating
Company) must be creditworthy; loans must be so sound as to reasonably
assure repayment; and SBA will consider nine specific factors in its
lending criteria. The factors consist of: (a) Character, reputation,
and credit history of the applicant (and the Operating Company, if
applicable), its Associates, and guarantors; (b) Experience and depth
of management; (c) Strength of the business; (d) Past earnings,
projected cash flow, and future prospects; (e) Ability to repay the
loan with earnings from the business; (f) Sufficient invested equity to
operate on a sound financial basis; (g) Potential for long-term
success; (h) Nature and value of collateral (although inadequate
collateral will not be the sole reason for denial of a loan request);
and (i) The effect any affiliates (as defined in part 121 of this
chapter) may have on the ultimate repayment ability of the applicant.
SBA proposes to revise this regulation as discussed below.
In revising Sec. 120.150, SBA would retain the requirement that
the applicant (including an Operating Company) must be creditworthy and
that loans must be so sound as to reasonably assure repayment,
consistent with section 7(a)(6) of the Small Business Act.
SBA is proposing to incorporate into the regulation a new
requirement that Lenders and Certified Development Companies (CDCs)
must use appropriate and prudent generally acceptable commercial credit
analysis processes and procedures consistent with those used for their
similarly-sized, non-SBA guaranteed commercial loans. In using such
appropriate and prudent processes and procedures, Lenders and CDCs
would be required to underwrite SBA loans in the same manner in which
the Lenders and CDCs underwrite their similarly-sized, non-SBA-
guaranteed commercial loans where they bear all risk of loss in the
case of loan default. SBA is aware that some SBA Supervised Lenders (as
defined in 13 CFR 120.10) and some CDCs do not make non-SBA guaranteed
commercial loans, and therefore do not have comparable processes and
procedures for non-SBA guaranteed commercial loans. Therefore, the
proposed language regarding non-SBA guaranteed commercial loans would
not apply to such SBA Supervised Lenders and CDCs. For these SBA
Supervised Lenders and CDCs, SBA has and would continue to require that
they submit their credit policies, including credit scoring models, for
review by SBA during the participant application process and/or during
lender oversight processes in accordance with Loan Program Requirements
as defined in 13 CFR 120.10.
SBA believes that allowing Lenders and CDCs to use appropriate and
prudent commercially acceptable credit analysis processes and
procedures consistent with those used for their similarly-sized, non-
SBA guaranteed commercial loans will encourage Lenders and CDCs to
participate in the 7(a) loan program because of alignment between their
processes for guaranteed and non-guaranteed loans. This will allow CDCs
to align with the credit processes and procedures of the 504 Loan
Program's Third Party Lenders. SBA also believes this may encourage
Lenders and CDCs to make smaller loans by reducing the underwriting
burden, including time and costs.
SBA also proposes adding language to Sec. 120.150 to permit
Lenders, CDCs, and SBA to use a business credit scoring model. Lenders
and CDCs may use SBA's Small Business Scoring Service (SBSS) credit
scoring model. Lenders and CDCs may also use other credit scoring
models; however, when doing so, Lenders and CDCs must be able to
validate the credit scoring model and must document with appropriate
statistical methodologies that their credit analysis procedures are
predictive of loan performance, and they must provide that
documentation to SBA upon request and during oversight reviews. Credit
scoring models could incorporate, for example, the earnings and
cashflow of an applicant, equity, or collateral, in which case those
factors would not necessarily be separately considered by a Lender or
CDC unless otherwise specified by Loan Program Requirements (e.g.,
where SBA requires an equity injection for certain project financing).
SBA would continue to require new SBA Supervised Lender applicants and
CDCs to submit their credit policies in accordance with Loan Program
Requirements; as part of this process, SBA would require that these
policies include any credit scoring models that the applicant intends
to use for SBA lending at the time of application. SBA may use a
business credit scoring model for non-delegated loan processing. SBA
believes that allowing Lenders and CDCs to use credit scoring models
for credit underwriting will result in more lenders making more smaller
loans because the costs for making the small loans will decrease. SBA
anticipates that credit scoring models will primarily be used for small
loans. SBA anticipates that the higher an applicant's requested loan
amount is, the more likely it will be that a Lender or CDC will conduct
more traditional underwriting in accordance with their credit analysis
processes and procedures consistent with those used for their
similarly-sized, non-SBA guaranteed commercial loans.
The use of credit scoring models will not replace the requirement
for Lenders and CDCs to comply with other Loan Program Requirements,
such as, ensuring the project meets program eligibility requirements,
adequate controls on disbursements are in place, providing accurate
descriptions of uses of proceeds, and documenting that credit is not
available elsewhere.
Modernizing SBA's lending criteria may result in the leveraging of
technology by Lenders, including credit
[[Page 64726]]
scoring, to assess a loan's risk more quickly without compromising the
credit quality of the overall 7(a) and 504 portfolios and possibly
reducing fraud. A Congressional Research Service report reviewing the
use of data by marketplace lenders indicates that accuracy of credit
assessments may improve by using data and advanced statistical
modeling, leading to fewer delinquencies and write-offs.\1\
Additionally, using data in credit models could also allow Lenders,
CDCs, and SBA to make credit assessments on applicants with little or
no traditional credit history. According to a U.S. Department of the
Treasury Report, industry proponents state that the use of data and
modeling techniques for underwriting is a promising source of
innovation that benefits small businesses.\2\ Use of data may allow
reduction in the cost of acquiring customers, automation of the
origination of loans and the collection of loan documentation, and
reduction in fraud.\3\
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\1\ Congressional Research Service, ``Marketplace Lending:
Fintech in Consumer and Small-Business Lending,'' September 4, 2018,
Summary page and page 8 at <a href="https://crsreports.congress.gov/product/pdf/R/R44614">https://crsreports.congress.gov/product/pdf/R/R44614</a>.
\2\ U.S. Department of the Treasury, ``Opportunities and
Challenges in Online Marketplace Lending,'' May 10, 2016, page 19 at
<a href="https://home.treasury.gov/system/files/231/Opportunities_and_Challenges_in_Online_Marketplace_Lending_white_paper.pdf">https://home.treasury.gov/system/files/231/Opportunities_and_Challenges_in_Online_Marketplace_Lending_white_paper.pdf</a>.
\3\ Ibid.
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SBA proposes to revise this section to state that, as part of
considering whether the applicant (including an Operating Company) is
creditworthy and the loan is so sound as to reasonably assure
repayment, SBA, Lenders, and CDCs may consider (as applicable) three
specific criteria when approving loans: (a) The credit score or credit
history of the applicant (and the Operating Company, if applicable),
its Associates and any guarantors; (b) The earnings or cashflow of the
applicant; or (c) Where applicable, any equity or collateral of the
applicant. SBA believes consideration of these factors may be necessary
to determine whether a small business is creditworthy and there is
reasonable assurance of repayment.
Under the proposed rule, SBA, Lenders, and CDCs may consider the
credit score or credit history of the applicant (including any
Operating Company, if applicable), any Associates of the applicant, and
any individuals or entities that will guarantee the loan. SBA is
removing the requirement to consider character and reputation. The
lending industry commonly uses the terms character and credit history
interchangeably. The term credit history has a clearer meaning in the
context of loan underwriting and credit review. Reputation is difficult
to define and apply as a component of loan underwriting and credit
review. SBA, Lenders, and CDCs may also consider an applicant's
earnings and cashflow (based on historical financial information or
projections, depending on whether the applicant is an existing business
or a startup) as part of the analysis to ensure that the applicant is
creditworthy, and the loan is so sound as to reasonably assure
repayment. SBA notes that some businesses, such as startups or new
businesses, may not yet have historical data regarding earnings and
cashflow, and as such, use of realistic projections would be reasonable
and prudent. Where applicable, SBA, Lenders, and CDCs may also consider
any equity or collateral of the applicant. In continuing with SBA's
current policy, however, inadequate collateral would not be the sole
reason for denial of a loan application, as some businesses may not
have sufficient collateral available. There may also be circumstances
where equity must be considered, such as where SBA requires an equity
injection for certain project financing, e.g., for start-up businesses
and certain changes of ownership.
SBA's proposed rule streamlines SBA's lending criteria by reducing
the number of factors that are required to be applied in determining
creditworthiness and reasonable assurance of repayment and allows for
flexibility. Reducing the required factors does not prevent Lenders,
CDCs, or SBA from considering other appropriate factors, particularly
if the Lender's or CDC's generally acceptable commercial credit
analysis processes and procedures for their similarly-sized, non-SBA-
guaranteed commercial loans require review of additional factors. SBA
will continue to provide further guidance regarding creditworthiness
and reasonable assurance of repayment in Loan Program Requirements.
Section 120.160--Loan Conditions
Current Sec. 120.160(c) states that for 7(a) and 504 loans SBA
requires hazard insurance on all collateral and does not distinguish
this requirement by loan size. SBA has determined that the hazard
insurance requirement can be burdensome for the smallest businesses
borrowing the smallest amount of money. SBA proposes to modify the
requirement for hazard insurance for all 7(a) and 504 loans $150,000
and under to create flexibility for SBA Lenders. SBA proposes revising
this regulation to state that SBA requires hazard insurance for loans
greater than $150,000. SBA will include guidance in the Loan Program
Requirements for loans of $150,000 or under, that SBA Lenders must
follow the hazard insurance policies and procedures they have
established and implemented for their similarly-sized, non-SBA-
guaranteed commercial loans. SBA Lenders must continue ensuring that
borrowers obtain flood insurance per Sec. 120.170 when required under
the Flood Disaster Protection Act of 1973 (Sec. 205(b) of Pub. L. 93-
234; 87 Stat. 983 (42 U.S.C. 4000 et seq.)).
Section 120.193--Reconsideration After Denial
Under current Sec. 120.193, the process for reconsideration after
denial of a loan application or loan modification request in the 7(a)
and 504 Loan Programs states that final reconsideration is made by the
Director of the Office of Financial Assistance. To facilitate fair and
expeditious reconsiderations, SBA proposes revising this regulation to
state that the Director of the Office of Financial Assistance or the
Director's designee(s) may make the final decision on reconsideration.
For purposes of 7(a) loan applications, the Director's designee would
include the Chief, 7(a) Loan Policy. For purposes of 504 loans, the
Director's designee would include the Chief, 504 Loan Policy. From time
to time, SBA may change the designee(s) and would do so in accordance
with published Delegations of Authority. Further, SBA proposes also
revising this regulation to provide the Administrator with the
authority, solely within the Administrator's discretion, to review a
reconsideration request and make the final Agency decision. Finally,
the proposed regulation would state that the Administrator's
discretionary authority does not create any additional appeal rights
for the applicant that are not otherwise specified in regulation.
Section 120.202--Restrictions on Loans for Changes of Ownership
Current Sec. 120.202 restricts Borrowers from using 7(a) loan
proceeds to purchase a portion of a business or a portion of another
owner's interest. SBA proposes to revise this section to allow
Borrowers to use 7(a) loan proceeds to fund partial changes of
ownership in addition to full changes of ownership. The proposed
revision will allow a Borrower to purchase a portion of the business or
a portion of an owner's interest in a business, or to purchase the
entire business or an owner's entire interest. A Borrower could also
purchase the partial or entire interests of multiple owners. This
revision will allow Borrowers to use 7(a) loan proceeds to fund partial
changes of
[[Page 64727]]
ownership and will help provide employees a path to ownership.
SBA has determined there is a need to assist small businesses to
carry out partial changes of ownership. For example, the mass
retirement of Baby Boomers is creating a glut of businesses that must
either undergo a change of ownership or close. SBA currently authorizes
complete changes of ownership; however, a gap in financing exists for
those businesses that wish to undergo a partial change of ownership,
such as when the owner is unable to find a buyer for a complete change
of ownership, and when employees are unable to find private financing
to capitalize a partial change of ownership. Partial changes of
ownership allow the seller to remain in place as a part owner and
employee, providing guidance and experience to ensure the success of
the business. Partial changes of ownership also allow businesses to
attract new owners or partners to expand, transfer interests in family
businesses to family members, and facilitate continuity for both the
business and employees.
ESOPs provide employees with a path to partial or complete
ownership in the business, which aligns the interests of the owner-
employees with the interest of the business. Further, ESOPs provide
participants with tax benefits and the opportunity for retirement
benefits. SBA currently facilitates employee ownership through ESOPs by
providing 7(a) loan guarantees to ESOPs to purchase a controlling
interest in the employer small business and by providing 7(a) loan
guarantees to an eligible employer small business for the sole purpose
of making a loan to an ESOP that results in the ESOP trust owning at
least 51 percent of the employer small business. This proposed rule
will not change SBA's current rules on ESOP lending. However, SBA has
determined that the costs for ESOP formation and remaining in
compliance with all applicable Internal Revenue Service, U.S.
Department of the Treasury, and Department of Labor regulations are
prohibitive barriers to entry and participation for most small
businesses. As described below in the Regulatory Impact Analysis, from
Fiscal Years 2018 through 2021, SBA approved a total of only 17 7(a)
loans to assist an ESOP in acquiring 51% or more of a business,
indicating that current policies are not accomplishing the Agency's
intended goal of increasing employee ownership of businesses.
Accordingly, SBA proposes to remove its prohibition on partial
buyouts in the 7(a) Loan Program to fill the gap in financing and to
provide a path to ownership for employees.
Section 121.301--What size standards and affiliation principles are
applicable to financial assistance programs?
Section 121.301 states the size standards and affiliation
principles that are applicable to SBA's financial assistance programs.
Paragraph (f) details how affiliation principles are applied for the
7(a) Loan Program, the 504 Loan Program, the Microloan Program, the ILP
Program, the Business Disaster Loan Programs (except for the COVID EIDL
Disaster Loan Program),\4\ and the SBG Program. This paragraph
currently has seven sub-paragraphs, each of which details a separate
affiliation principle that must be applied to the applicant and other
entities to determine whether the entities are affiliated. The
determination of affiliation is necessary to ensure that an applicant
is ``small'' for purposes of eligibility for SBA financial assistance
and to ensure that the applicant (including affiliates) does not exceed
the maximum guaranty amount available. The seven sub-paragraphs
consider: (1) affiliation based on ownership, including the principal
of control of one entity over another; (2) affiliation arising under
stock options, convertible securities, and agreements to merge,
including the principal of control of one entity over another; (3)
affiliation based on management, including the principal of control of
one entity over another; (4) affiliation based on identity of interest
between close relatives; (5) affiliation based on franchise and license
agreements, including the principal of control of one entity over
another; (6) determining the concern's size; and (7) exceptions to
affiliation.
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\4\ The affiliation principles for the COVID EIDL Disaster Loan
Program are contained in paragraph (g) of Sec. 121.301.
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Participating lenders and the public have requested simplification
of the affiliation rules for SBA's financial assistance programs, and
recent Congressional actions have streamlined the affiliation rules for
certain circumstances. For example, certain temporary COVID-19 pandemic
relief programs enacted by Congress streamlined SBA's financial
assistance affiliation requirements to speed relief to small businesses
in hard-hit industries. The CARES Act created the Paycheck Protection
Program (PPP), which is a temporary 7(a) Loan Program, and for that
program, Congress waived affiliation requirements for businesses
operating under North American Industry Classification System (NAICS)
Code 72 (Accommodations and Food Services), for small businesses
operating under a franchise agreement listed on SBA's Franchise
Directory, and for small businesses that were financed by a Small
Business Investment Company (SBIC). Similarly, the American Rescue Plan
Act (ARPA), Public Law 117-2, enacted on March 11, 2021, created the
Restaurant Revitalization Fund (RRF), a program to assist hard-hit
eligible restaurants and other food-related businesses that experienced
pandemic-related revenue loss, and for that program, Congress provided
a streamlined definition of an ``affiliated business'' in section
5003(a)(2). In SBA's interim final rule on ``Disaster Loan Program
Changes'' (86FR50214, September 8, 2021), SBA adopted the simplified
RRF definition of ``affiliated business'' for the temporary COVID EIDL
program so that those applicants could more easily identify affiliates
and complete the loan application process, with the expectation that
this simplification would expedite the flow of funds to applicants that
still needed relief from the COVID-19 pandemic.
Drawing on the successful experience of affiliation streamlining
under the temporary pandemic relief programs and mindful of lender and
public comments requesting affiliation streamlining for the permanent
financial assistance programs, SBA is proposing to streamline the
financial assistance affiliation requirements as set forth in this
proposed rule.
Accordingly, SBA proposes to revise the Sec. 121.301 affiliation
provisions to simplify the program requirements, streamline the
application process for SBA's programs, and facilitate the review of
such applications. SBA proposes to specifically remove the principle of
control of one entity over another as a separate basis for finding
affiliation because the concept of control has proven particularly
burdensome for applicants and lenders to understand and implement. For
example, determining whether an entity has control over another has at
times required in-depth analyses of franchise and license agreements
and management agreements and delayed application processing. SBA
believes that affiliation based on ownership also captures much of the
control component, and control as a separate basis for finding
affiliation is not necessary.
SBA is revising Sec. 121.301 to add an introductory paragraph at
the beginning to include the Small Business Act definition of a small
business concern as one which is independently owned and operated, and
which is not dominant in its field of operation. SBA interprets this
statutory definition to require, in certain circumstances, the
inclusion of other
[[Page 64728]]
entities (``Affiliates'') owned by the applicant or an owner of the
applicant in determining the size of the applicant.
SBA is revising Sec. 121.301(f)(1), ``Ownership,'' to remove the
principle of control of one entity over another when determining
affiliation. SBA is proposing to expand upon the definition of
``ownership'' under paragraph (f)(1) to clarify the thresholds of
ownership at which SBA considers an Applicant to be affiliated with an
individual or another business. The Small Business Act defines a small
business concern as one which is independently owned and operated and
which is not dominant in its field of operation. Accordingly, SBA will
also clarify that certain instances of affiliation by ownership will
only arise if the Applicant and another business operate in the same 3-
digit NAICS subsector to restrict affiliates to businesses in the same
field. Paragraph (f)(1)(i) will state that businesses in which the
Applicant is a majority owner are affiliates of the Applicant.
Paragraph (f)(1)(ii) describes affiliation with businesses that own a
majority of the Applicant as well as businesses in the same 3-digit
NAICS subsector that are majority-owned by the Applicant's owner.
Paragraph (f)(1)(iii) describes affiliation with another business when
the Applicant and the other business are both majority-owned by the
same individual and operate in the same 3-digit NAICS subsector.
Paragraph (f)(1)(iv) describes a 20 percent threshold of ownership for
affiliation with the Applicant when the Applicant does not have a
majority owner if a 20% owner also operates in the same 3-digit NAICS
subsector as the Applicant. Paragraph (f)(1)(v) will state that if the
Applicant does not have a majority owner and an individual owns 20
percent or more of the Applicant, businesses that are majority-owned by
that owner and operate in the same 3-digit NAICS subsector will be
affiliates of the Applicant. Paragraph (f)(1)(vi) will state that
ownership interests of spouses and minor children will be combined when
determining ownership interest (as interests may be held in trust by
parents for minors). Finally, paragraph (f)(1)(vii) will state that SBA
will analyze the pro rata beneficial ownership of entities to determine
affiliation and provide an example of the combined interest of an
individual and an entity that is wholly-owned by the same individual.
SBA believes this proposed regulatory language provides increased
detail and clarity for lenders to apply, and also eliminates the
confusion and frustration of determining affiliation by control.
Because SBA is revising its regulation generally by removing the
principle of control of one entity over another as a separate basis for
finding affiliation, the proposed rule would also revise Sec.
121.301(f)(2), ``Stock options, convertible securities, and agreements
to merge,'' paragraphs (f)(2)(i) and (iv). Where paragraph (f)(2)(i)
currently states that SBA considers stock options, convertible
securities, and agreements to merge (including agreements in principle)
to have a present effect on the power to control a concern, the revised
paragraph (f)(2)(i) would state that these items will have a present
effect on ownership of the entity. SBA proposes to revise paragraph
(f)(2)(iv) by deleting the first sentence where SBA currently states
SBA will consider whether an individual, concern or other entity that
controls one or more other concerns cannot use options, convertible
securities, or agreements to appear to terminate such control before
actually doing so. The proposed rule would remove the first sentence of
paragraph (f)(2)(iv) because it is superfluous; the remaining sentence
of the paragraph clearly states that SBA will not give present effect
to the ability of an entity to divest in the future to avoid a finding
of ownership.
SBA proposes to remove paragraph (f)(3), affiliation based on
management, because SBA is revising its regulation generally by
removing the principal of control of one entity over another from
consideration of affiliation. SBA believes it should not interfere in a
business owner's right to enter into a service agreement with a
management company. The business owner's decision to hire a management
company is a decision best left to the business.
The proposed rule would also remove paragraph (f)(4), affiliation
based on identity of interest, because SBA believes it is inherently
unfair and impractical to require close relatives to provide multiple
years' worth of financial statements for review by a lender and by SBA
when the close relative is not a principal of the applicant business.
For example, the current rule requires a sole proprietor who is
requesting an SBA direct or guaranteed loan to provide their sibling's
business's financial statements for review when the sibling is in the
same or similar industry in the same geographic area. SBA believes this
requirement imposes a chilling effect on applicants that may elect to
use alternative predatory lending when relatives will not disclose
their business financial statements for transactions in which they have
no ownership interest. However, as stated above, SBA will still combine
the ownership interests of spouses and minor children when determining
affiliation by ownership.
SBA proposes to remove paragraph (f)(5), affiliation based on
franchise and license agreements. Because SBA is removing the principal
of control of one entity over another from its affiliation
consideration, this paragraph is no longer needed. Upon the effective
date of this rule, SBA would no longer publish the SBA Franchise
Directory. SBA Lenders retain the responsibility for ensuring that the
applicant meets all Loan Program Requirements. SBA will continue to
collect a franchise identifier number on each loan for the purpose of
completing mandatory reporting requirements to Congress and for
responding to congressional inquiries. Upon entering a loan into SBA's
electronic transmission system (E-TRAN), SBA Lenders will, for a
franchise that is already listed in E-TRAN, pick the franchise from a
list, for example a dropdown menu, or, for franchises that are not yet
listed in E-TRAN, the SBA Lender will request a franchise identifier
number, which SBA will provide without regard to whether the franchise
meets SBA eligibility rules. SBA will use a franchise identifier number
rather than allowing the SBA Lender to type in the name of the
franchise so that SBA can ensure an exact match to the appropriate
franchise.
SBA Lenders will still be expected to examine Franchised businesses
for affiliation based on ownership. For example, when lending to a
Franchised business, the SBA Lender should determine who owns the
applicant business and any businesses the applicant owns in accordance
with these regulations. However, neither the SBA Lender nor SBA will
review the applicant Franchised business for affiliation with other
entities beyond ownership; the applicant business will not be
considered affiliated with the Franchisor or other Franchised
businesses except by ownership.
SBA Lenders will also be expected to ensure the applicant meets
Loan Program Requirements, including but not limited to eligibility and
SBA's lien priority. Some of these determinations may require a limited
examination of the Franchise Agreement (or similar agreement) to
determine whether there are any restrictions that would violate Loan
Program Requirements (e.g., discriminatory hiring practices,
restrictions on security interests or lien priority for the Franchisor,
etc.). For example, regardless of restrictions on security interests
for Franchisor's collateral present in Franchise
[[Page 64729]]
Agreements, SBA Lenders must ensure that the SBA Lender obtains, for
the 7(a) loan program, a first lien, and for the 504 loan program, a
second lien, on any property, equipment, inventory, etc. purchased with
loan proceeds.
Compliance With Executive Orders 12866, 12988, 13132, and 13563, the
Paperwork Reduction Act (44 U.S.C., Ch. 35), the Congressional Review
Act (5 U.S.C. 801-808), and the Regulatory Flexibility Act (5 U.S.C.
601-612)
Executive Order 12866
The Office of Management and Budget has determined that this
rulemaking is a ``significant regulatory action'' under Executive Order
12866. SBA has drafted a Regulatory Impact Analysis for the public's
information in the next section. Each section begins with a core
question.
A. Regulatory Objective of the Proposal
Is there a need for this regulatory action?
The Agency believes it needs to streamline and reduce regulatory
burdens to facilitate robust participation in the business loan
programs that assist small and underserved U.S. businesses and the
disaster loan programs that assist businesses of all sizes with
recovery from disasters.
Regarding modernization of lending criteria, as a result of the
emergency lending programs mandated to address economic impacts of the
pandemic, SBA significantly leveraged the use of technology in loan
delivery to capture efficiencies that can be applied across programs to
increase access and lower costs for both participating lenders and the
public. SBA also understands that lenders are currently leveraging data
analytics tools and machine learning modelling in their conventional
lending criteria models, particularly for small dollar loans, and that
by modernizing SBA's lending criteria to match lending practices
already being implemented by its participating lenders, SBA will
encourage more lender participation in its programs. For these reasons,
among others, SBA is proposing the changes to SBA's lending criteria
rules at 13 CFR 120.150.
By dispensing with the requirement for hazard insurance for all
7(a) and 504 loans $150,000 or less, SBA will eliminate a burdensome
regulatory requirement for small loans while providing SBA Lenders with
the flexibility use their own policies for similarly-sized non-SBA
guaranteed loans regarding hazard insurance on these loans.
By permitting the Director, Office of Financial Assistance, to
delegate reconsideration requests to a designee, SBA will facilitate
fair and expeditious review of reconsideration requests and provide
finality to applicants that are in the process of making important
financial decisions.
SBA is revising its affiliation regulations in response to
continuing requests by SBA's participating lenders and the public. SBA
believes that revising its affiliation regulations will result in
expansion of credit to those who cannot obtain credit elsewhere and
increased understanding of and compliance with program rules while
decreasing time spent reviewing an applicant for eligibility.
There is also a need for SBA to address financing for changes of
ownership. Orderly transitions of business ownership are beneficial
both to the small business and its employees. Employees acquiring
partial ownership interest in small businesses assists with transitions
of ownership, especially when there is more than one current owner and
one of the current owners intends to sell their equity stake in the
small business to one or more employees who may not have an equity
ownership interest at that time. The small business benefits by
remaining in operation when it might otherwise be forced to close, and
the employees benefit by having a path to ownership in a small business
that remains in operation. Partial changes of ownership among existing
owners of a small business permit such businesses to attract new
employees as partial owners (e.g., allowing a dental group to attract a
new dentist to the practice and providing the new dentist with partial
ownership in the small business). Financing for changes of ownership
also permit family members to purchase partial ownership in a family-
run small business to ensure continuation of the small business after
the retirement or death of an owner. However, SBA does not fully meet
the financing needs of small businesses regarding partial changes of
ownership due to current restrictions, necessitating this proposed
rule.
Historically, SBA has permitted loan proceeds for use only in three
situations involving a change of ownership: (1) A complete change of
ownership; (2) a Partner Buyout; and (3) where an ESOP purchases a
controlling interest (51% or more) in the employer small business from
the current owner(s). Outside of loans to ESOPs, SBA's current
regulations do not permit 7(a) loan proceeds to be used for partial
changes of ownership.
Over the past 4 completed fiscal years (FY 2018 through FY 2021),
SBA approved 31,940 7(a) loans where loan proceeds were used to affect
a change of ownership. ESOP loans (loans to assist an ESOP trust in
acquiring 51 percent or more of the equity ownership in the small
business concern) accounted for only 17 of the 31,940 loans used for a
change of ownership in the four years between FY 2018 and FY 2021, or
fewer than five loans per year, and therefore ESOP loans have not made
the anticipated impact in transitioning small businesses to employee
ownership as originally intended by the Agency. For these reasons, SBA
intends to lift the prohibition on partial changes of ownership.
Current SBA policy only permits the selling owner(s) to remain as
an owner or as an Associate or Key Employee of the small business in
cases where the SBA guaranteed loan is made to the ESOP. SBA also
permits 7(a) loans to an eligible employer small business for the sole
purpose of making a loan (often referred as a back-to-back loan) to an
ESOP that results in the ESOP owning at least 51 percent of the
employer small business concern. However, the costs associated with the
creation of an ESOP and ongoing compliance with associated regulations
may be cost-prohibitive for small businesses.
The organizational costs for unleveraged ESOPs start at $80,000
with additional annual compliance reporting obligations.\5\ In a
leveraged ESOP transaction, the initial costs increase by 25 percent or
more.\6\ SBA believes these costs to be prohibitive for many small
businesses that qualify for SBA assistance. Consequently, SBA intends
for the proposed rule change to allow for partial changes of ownership
for employee ownership without the additional upfront and ongoing costs
incurred by the small business in the formation and operation of an
ESOP trust.
---------------------------------------------------------------------------
\5\ <a href="https://www.nceo.org/articles/too-small-for-esop">https://www.nceo.org/articles/too-small-for-esop</a> ``How Small
is Too Small for an ESOP?'' by the National Center for Employee
Ownership, updated July 29, 2022.
\6\ Ibid.
---------------------------------------------------------------------------
The proposed changes will reduce regulatory burdens, modernize
program delivery through the use of data analytics tools and machine
learning modelling, reduce the number of hours spent processing an
application to deliver a loan for both SBA and lenders and increase
access to capital.
[[Page 64730]]
B. Benefits and Costs of the Rule
What are the potential benefits and costs of this regulatory action?
SBA does not anticipate significant additional costs or impact on
the subsidy to operate the 7(a), 504, Microloan, ILP, SBG and Business
Disaster Loan Programs under these proposed regulations.
SBA anticipates a minor impact to the subsidy as a result of
approximately 800 new loans per year in 7(a) loan activity for loans
involving a partial change of ownership. Over the past 4 completed
fiscal years (FY 2018 through FY 2021), SBA processed a total of
206,415 7(a) loans, of which 31,940 loans (approximately 15.5%)
included loan proceeds used to affect a change of ownership. ESOP loans
(loans to assist an ESOP trust in acquiring 51 percent or more of the
equity ownership in the small business concern) accounted for only 17
loans in the four years between FY 2018 and FY 2021, or fewer than five
loans per year, and therefore ESOP loans have not made the anticipated
impact in transitioning small businesses to employee ownership as
originally intended by the Agency.
In revising SBA's lending criteria at 13 CFR 120.150, SBA
anticipates that modernizing SBA's lending criteria to include credit
scoring will not compromise the credit quality of the overall 7(a) and
504 portfolios. When using a credit scoring model other than SBA's SBSS
model, Lenders and CDCs must be able to validate the credit scoring
model and must document that their credit analysis procedures are
predictive of loan performance; therefore, no reduction in credit
quality is anticipated as a result of using credit scoring models.
Streamlining the number of criteria lenders consider when approving
loans, and for regulated lenders, using the same commercial credit
analysis processes and procedures consistent with those used for their
similarly-sized, non-SBA guaranteed commercial loans will not
negatively impact the credit quality of the 7(a) and 504 Loan Program
portfolios and will provide a time saving ranging from zero to several
hours per loan depending on the size and complexity of the loan. SBA
anticipates that modernizing SBA's lending criteria and allowing
Lenders and CDCs to use their own processes and procedures will result
in an increase in the number of participating lenders and loans in both
programs, which would mean increased access to capital for small
businesses.
The primary goal driving the revisions to 13 CFR 120.150 is to
encourage and facilitate more lenders to make more small dollar loans.
SBA believes these streamlined rules will result in increased lender
participation, particularly for community banks, credit unions and
other mission-based lenders that generally serve more rural communities
and underserved populations with smaller dollar loans. Currently, a
substantial portion of SBA's portfolio is made by a small number of
lenders: the top 25 lenders that participate in the 7(a) Loan Program
make 40 percent of total loans (based on outstanding balance), and the
top 2 lenders make 12 percent of the loans (based on outstanding
balance). Meanwhile, the number of participating 7(a) Lenders has
steadily decreased each year from FY 2010 with 2,034 Lenders to FY 2019
with 1,632 Lenders.
With more community-based lenders making small loans, borrowers
that would not otherwise be able to obtain credit elsewhere will
benefit by having access to credit being extended at non-predatory
interest rates, fees, and terms. For example, Loan Program Requirements
set the maximum variable interest rate that may be charged on a 7(a)
Loan of $50,000 or less at 6.5 percentage points over the base rate
(e.g., prime rate). Since March 16, 2020, the prime rate is currently
5.5 percent, which equates to a maximum interest rate of 12 percent for
a 7(a) Loan up to $50,000 (loans above $50,000 have lower maximum
interest rates) and a maturity of up to 10 years. This is in comparison
to a large online lender offering small business loans with annual
percentage rates up to 98.4 percent with a maximum maturity of 36
months.\7\ A loan for $50,000 made through the 7(a) Loan Program at 12
percent over 10 years results in a monthly payment of $717, whereas a
loan made by an online lender, at for example, 28 percent interest over
3 years results in a monthly payment more than three times higher at
$2,068. The smaller monthly payments accessible through the 7(a) Loan
Program represent a significant increase in monthly capital available
for other expenses.
---------------------------------------------------------------------------
\7\ U.S. Department of the Treasury, ``Opportunities and
Challenges in Online Marketplace Lending,'' May 10, 2016, page 10.
---------------------------------------------------------------------------
By revising 13 CFR 120.160 to state that SBA requires hazard
insurance only for loans greater than $150,000, SBA anticipates a de
minimis impact on annual subsidy calculation for the 7(a) 504 Loan
Programs. The primary benefit to removing the requirement for hazard
insurance on these small loans is to increase the speed with which
lenders can disburse loan proceeds after loan approval. Hazard
insurance is only impactful when it is protecting collateral.
Currently, SBA does not require collateral for loans $25,000 or less,
so these loans are not impacted by the proposed revision to hazard
insurance requirements. Further, Lenders will continue to require
hazard insurance for loans of $150,000 and under when tangible assets
such as real estate or equipment are financed with the loan in
accordance with their non-SBA guaranteed policies and federal
regulators. As such, although lenders will continue to require hazard
insurance in accordance with their similarly-sized non-SBA guaranteed
policies, they will experience a time savings by no longer providing
SBA with documentation of proof of hazard insurance as part of SBA's
loan origination and monitoring requirements. Further, even with hazard
insurance in place, the lender and/or SBA's recovery on assets in this
dollar range is minimal after the costs of liquidation and litigation
are considered. In the 7(a) Loan Program, SBA is not listed as a loss
payee on hazard insurance policies, so SBA does not have data regarding
hazard insurance collections. However, from October 1, 2020, through
December 31, 2021, the 504 Loan Program reported 270 instances of
collection on a hazard insurance policy, 30 of which were for loans
$150,000 or less. This is an average of 2 collections per month for
loans $150,000 or less in a portfolio of approximately 56,000 total
outstanding loans and 5,962 loans of $150,000 or less. Although SBA
does not collect hazard insurance payment data in the 7(a) Loan
Program, it is reasonable to assume the 7(a) Loan Program experiences
approximately the same hazard insurance collection rates. As of
December 31, 2021, the 7(a) Loan Program had approximately 100,000
outstanding loans of $150,000 or less, which approximates to 400
instances where a 7(a) lender would receive a hazard insurance
collection, representing a minimal impact in the 7(a) Loan Program. The
benefit to SBA for requiring hazard insurance at this amount is
minimal, while lenders will save time and be able to disburse loan
proceeds more quickly after loan approval by using their own procedures
and not having to provide additional documentation evidencing insurance
to SBA.
Revising 13 CFR 120.193 will allow the Director of the Office of
Financial Assistance to delegate to a designee the authority to make
final decisions on
[[Page 64731]]
reconsideration after denial of a loan application or loan modification
request in the 7(a) and 504 Loan Programs. SBA does not anticipate any
additional costs or impact on the subsidy to operate the 7(a) and 504
Loan Programs under this proposed regulation. Additionally, the number
of loans impacted by this change is very low in comparison to the
number of loans processed in both loan programs. On average, the 7(a)
Loan Program accounts for 10 to 12 requests per year, and the 504 Loan
Program accounts for 28 to 41 requests per year. For comparison, in
fiscal year 2021, the 7(a) Loan Program approved 51,856 loans, and the
504 Loan Program approved 9,676 loans. Lenders, CDCs, and applicants
will benefit in a faster turn time for decision-making.
SBA does not anticipate significant additional costs or impact on
the subsidy to operate the 7(a), 504, Microloan, ILP, SBG and Business
Disaster Loan Programs under the proposed regulations at 13 CFR 121.301
regarding affiliation. Complex affiliation rules limit accessibility to
SBA's business loan programs, with an outsized impact on underserved
borrowers who may struggle to access traditional capital or other
resources such as attorneys and CPAs. SBA anticipates that providing
clear and streamlined regulatory guidance for its affiliation rules
will result in an increase in the number of participating lenders and
loans and will encourage more borrowers to apply. SBA anticipates that
participating lenders will spend less time screening applicants for
eligibility under SBA Size Standards because lenders and applicants
will readily be able to determine which entities they are affiliated
with, and lenders will have fewer documents to examine.
C. Alternatives
What alternatives have been considered?
SBA considered eliminating even more regulatory burdens and
determined the proposed rules strike the right balance in responsibly
streamlining regulations without substantially increasing the risk of
waste, fraud, or abuse of the programs or otherwise threatening the
integrity of the business loan programs or taxpayer dollars. Regarding
affiliation, SBA has implemented several variations of its affiliation
rules as discussed above, and SBA has determined the simplest
affiliation rules were the least burdensome.
SBA also considered limiting partial changes of ownership to
employees of the business; however, the Agency believes this may
restrict small businesses in need of additional expertise from
providing a percentage of ownership as an incentive to recruit and
retain new highly skilled employees. For example, an existing dental
practice may recruit a new dentist by offering the dentist an equity
ownership in the business as a hiring incentive. For this reason, SBA
determined that partial changes of ownership should not be exclusive to
existing employees of the business.
Executive Order 12988
This action meets applicable standards set forth in sections 3(a)
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize
litigation, eliminate ambiguity, and reduce burden. The action does not
have preemptive effect or retroactive effect.
Executive Order 13132
This proposed rule does not have federalism implications as defined
in Executive Order 13132. It will not have substantial direct effects
on the States, on the relationship between the national government and
the States, or on the distribution of power and responsibilities among
the various levels of government, as specified in the Executive Order.
As such it does not warrant the preparation of a Federalism Assessment.
Executive Order 13563
A description of the need for this regulatory action and benefits
and costs associated with this action, including possible
distributional impacts that relate to Executive Order 13563, are
included above in the Regulatory Impact Analysis under Executive Order
12866.
Paperwork Reduction Act, 44 U.S.C. Ch. 35
SBA has determined that this proposed rule would require that the
following forms be revised: SBA Form 1919, ``Borrower Information
Form,'' SBA Form 1920, ``Lender's Application for Loan Guaranty for all
7(a) Loan Programs,'' SBA Form 1244, ``Application for Section 504
Loans,'' SBA Form 5--Disaster Business Loan Application, and SBA Form
5C--Disaster Home/Sole Proprietor Loan Application.
SBA Forms 1919 and 1920 are approved under OMB Control number 3245-
0348. SBA Form 1244 is approved under OMB Control number 3245-0071. SBA
Form 5 is approved under OMB Control number 3245-0017 and SBA Form 5C
is approved under OMB Control number 3245-0018.
SBA will revise SBA Form 1919, SBA Form 1920, and SBA Form 1244 to
conform to the lending criteria changes at 13 CFR 120.150. When lenders
choose to use a credit scoring model in accordance with 13 CFR 120.150,
the estimated hour burden for lenders will decrease when the credit
score incorporates consideration of certain lending criteria (e.g., the
earnings and cashflow of an applicant), in which case those factors
would not necessarily be separately considered by a lender unless
otherwise specified by Loan Program Requirements. However, SBA expects
that Lenders and CDCs will make more smaller loans due to the ability
to use credit scoring models, which increase the estimated burden hours
due to the increase in loans. This reporting requirement will be
included in the OMB-approved collections for the affected forms. The
other revisions to 120.150 (i.e., requirement that Lenders and CDCs use
appropriate and prudent generally acceptable commercial credit analysis
processes and procedures consistent with those used for their
similarly-sized, non-SBA guaranteed commercial loans, and criteria that
may be considered in lending criteria), will have a de minimis impact
on the estimated hour burden because regulated lenders must comply with
more rigorous lending criteria requirements from their federal
regulators, and SBA-Supervised Lenders and CDCs must continue to comply
with the credit policies submitted to OCRM.
SBA will revise SBA Form 1920 to conform to revisions at 13 CFR
120.130 and 13 CFR 120.202 to permit partial changes of ownership.
SBA will revise SBA Form 1919, SBA Form 1920, SBA Form 1244, and
SBA Form 5 to conform to the affiliation rule changes at 13 CFR
121.301, which will reduce the estimated hour burden for applicants and
lenders because SBA anticipates fewer entities will fall under the
definition of ``affiliate.''
Congressional Review Act, 5 U.S.C. Ch. 8
Subtitle E of the Small Business Regulatory Enforcement Fairness
Act of 1996, also known as the Congressional Review Act or CRA,
generally provides that before a rule may take effect, the agency
promulgating the rule must submit a rule report, which includes a copy
of the rule, to each House of the Congress and to the Comptroller
General of the United States. SBA will submit a report containing this
rulemaking and other required information to the U.S. Senate, the U.S.
House of Representatives, and the Comptroller General of the United
States. A major
[[Page 64732]]
rule under the CRA cannot take effect until 60 days after it is
published in the Federal Register. The Office of Information and
Regulatory Affairs has determined that this rulemaking is not a ``major
rule'' as defined by 5 U.S.C. 804(2). Therefore, this rulemaking is not
subject to the 60-day restriction.
Regulatory Flexibility Act, 5 U.S.C. 601-612
When an agency issues a rulemaking proposal, the Regulatory
Flexibility Act (RFA), 5 U.S.C. 601-612, requires the agency to
``prepare and make available for public comment an initial regulatory
analysis'' which will ``describe the impact of the proposed rule on
small entities.'' Although the rulemaking will impact all of the
approximately 2,897 7(a) Lenders, all of the approximately 216 CDCs,
all of the approximately 150 Microloan Intermediaries, all of the
approximately 35 ILP Intermediaries, and all of the approximately 44
Sureties that participate in the SBG Program, SBA does not believe the
impact will be significant because this proposal modifies and
streamlines existing regulations and procedures. However, as described
below, there may be impacts due to increased 7(a) loans for partial
changes of ownership.
SBA approved a total of 206,419 7(a) loans for the four-year period
between FY 2018 and the end of FY 2021 (not including PPP loans), of
which there were 31,940 loans that included proceeds used for a change
of ownership (an average of just under 7,985 loans per year, or 15.5
percent of 7(a) loans approved each year).
SBA estimates the burden for completing SBA Form 1919, ``SBA 7a
Borrower Information Form'', including time for reviewing instructions,
gathering data needed, and completing and reviewing the form, is 15
minutes per response. SBA will not need to change SBA Form 1919 as a
result of the proposed rule for partial changes of ownership because
the applicant simply writes in the dollar amount of the loan request
and the purpose of the loan. SBA anticipates the proposed rule allowing
partial changes of ownership will increase the number of 7(a) loans by
800 loans per year, with each of the loans representing a unique small
business applicant. SBA Form 1919 will not need to be revised due to
the proposed rule for SBLCs because Applicants use SBA Form 1919
regardless of whether their lender is an SBLC or some other type of
7(a) Lender.
The estimated burden for completing the SBA Form 1919, including
time for reviewing instructions, gathering data needed, and completing
and reviewing the form remains unchanged at 15 minutes per response.
SBA anticipates the proposed rules will result in an increase to loan
volume by a potential 1,225 loans per year \8\ representing 1,225
unique small business Applicants.
---------------------------------------------------------------------------
\8\ The 1,225 additional loans represents 800 additional loans
due to the proposed rule for partial changes of ownership and 425
new loans from the three new anticipated SBLC applicants.
---------------------------------------------------------------------------
An applicant completing the SBA Form 1919 will spend approximately
fifteen minutes per response in completing the form, at a cost of
$23.55 per loan application. This estimate represents a total time
burden cost of $28,849 for the 1,225 total anticipated additional
unique small business Applicants for loans for partial changes of
ownership and new loans from SBLCs, including Mission-Based SBLCs. This
small business Applicant burden estimate was derived from using the
median hourly rate for General and Operations Managers from the May
2021 National Occupational Employment and Wage Estimates for the United
States of $47.10 per hour,\9\ and increasing this rate by an additional
100 percent (an additional $47.10) to allow for the hourly costs for
overhead and benefits, bringing the total hourly cost to complete SBA
Form 1919 per applicant to $94.20 per hour (Base) multiplied by fifteen
minutes per response. The proposed rules will not change the time costs
of completing the revised SBA Form 1919 as the proposed rule changes
will not require the Applicant small business to provide any additional
responses in completing SBA Form 1919 other than those already
required.
---------------------------------------------------------------------------
\9\ Data available at the U.S. Bureau of Labor Statistics
website at <a href="https://www.bls.gov/oes/current/oes_nat.htm#11-0000">https://www.bls.gov/oes/current/oes_nat.htm#11-0000</a>.
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In revising 13 CFR 120.130 and 120.202 to permit partial change of
ownership, SBA will update the SBA Form 1920, ``Lender's Application
for Loan Guaranty for all 7(a) Loan Programs'', in Section ``O'', to
add a question for the Lender to indicate that the change of ownership
is a partial change of ownership. The current estimated burden for the
7(a) Lender in completing SBA Form 1920, including time for reviewing
instructions, gathering data needed, and completing and reviewing the
form is 25 minutes per response. Section ``O'' of SBA Form 1920 is
required to be completed in cases involving a change of ownership using
the loan proceeds. SBA Form 1920 currently requires the Lender to check
an ``N/A'' box if the loan does not finance a change of ownership and
answer an additional six ``Yes'' or ``No'' questions about the
circumstances for the change of ownership. It is anticipated the
additional language will be similar in length to the existing questions
of approximately 30 words per question, which should add approximately
10 seconds per application to read and respond to the question by
checking the yes or no box,\10\ which represents a cost increase to
lenders of approximately 11 cents per application.\11\
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\10\ The average silent reading rate for adults in English is
238 words per minute, based on an analysis of 190 studies with
18,573 participants by Brysbaert, Marc (April 12, 2019) How many
words do we read per minute? A review and meta-analysis of reading
rate, page 2, at <a href="https://psyarxiv.com/xynwg/">https://psyarxiv.com/xynwg/</a>.
\11\ Based on the mean hourly wage of $38.74 per hour for Loan
Officers as of May 2021 U.S. Bureau of Labor Statistics at <a href="https://www.bls.gov/oes/current/oes_nat.htm#13-0000">https://www.bls.gov/oes/current/oes_nat.htm#13-0000</a>.
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13 CFR 120.150, ``What are SBA's lending criteria?''
Based on industry feedback, SBA estimates Lenders and CDCs will
save anywhere from zero to 2 hours per loan under the proposed revision
of 13 CFR 120.150 to require that Lenders and CDCs must use appropriate
and prudent generally acceptable commercial credit analysis processes
and procedures consistent with those used for their similarly-sized,
non-SBA guaranteed commercial loans. The range in time saving is due to
the size and complexity of the loan and federally regulated lenders
continuing to underwrite loans in accordance with their own procedures.
Based on the average of the most recent 3 fiscal years, each year the
7(a) Loan Program approves 48,687 loans and the 504 Loan Program
approves 7,631 loans, for a total of 56,318 loans approved per year.
The mean hourly wage of a loan officer is $36.99 according to the May
2020 U.S. Bureau of Labor Statistics. SBA estimates a cost saving
ranging from $0 to $2,083,215 per year for Lenders and CDCs, calculated
by multiplying 56,318 (total loans approved per year) by $36.99 (mean
hourly wage of a loan officer). This revision will have no direct
impact on Applicants and possibly an indirect impact due to faster
processing times that could lead to faster loan approval.
SBA anticipates the proposal to allow Lenders and CDCs to use a
credit scoring model will increase the number of small loans approved
while generally decreasing the length of time required to process a
loan. Not all lenders will use credit scoring, and those that do will
limit credit scoring to small loans. SBA estimates lenders will save
from 2 to 4 hours per loan when they elect to use a credit scoring
model.
[[Page 64733]]
13 CFR 120.160, ``Loan Conditions''
SBA estimates Lenders and CDCs will save anywhere from 0.25 to 6
hours per loan over the life of the loan under the proposed revision of
13 CFR 120.160 to eliminate the requirement for hazard insurance on
loans $150,000 or less. The range in time saving is due to whether
lenders require hazard insurance on similarly-sized non SBA guaranteed
loans in accordance with their own procedures. Lenders that do not
require hazard insurance may save up to 6 hours over the life of the
loan when including the time required to monitor whether the policy
remains in place each year. Lenders that continue requiring insurance
will experience a time savings by no longer documenting proof of
insurance for SBA.
13 CFR 120.193, ``Reconsideration After Denial''
The Director of the Office of Financial Assistance processes an
average of 10 to 12 reconsideration requests for the 7(a) Loan Program
and 28 to 41 reconsideration requests for the 504 Loan Program each
year. Revising this rule will have a minimal impact on the overall
portfolio; however, to the individual applicants that are impacted by
reconsideration requests, a faster decision will allow the applicants
to quickly move forward with financing with a positive decision or
pursue other financing options with a negative decision.
Section 121.301, ``What size standards and affiliation principles are
applicable to financial assistance programs?''
The revisions to 13 CFR 121.301 will impact all of the
approximately 1,738 7(a) Lenders and 186 CDCs that make an SBA loan
annually (based on FY 2021 data), all of the approximately 150
Microloan Intermediaries, all of the approximately 44 Sureties that
participate in the SBG Program, and all of the applicants for each of
these programs and SBA's Disaster programs. SBA's proposal to
streamline its affiliation rules will increase the overall number of
loans made while simultaneously reducing the time required to process
each loan.
List of Subjects
13 CFR Part 120
Community development, Loan programs--business, Reporting and
recordkeeping requirements, Small businesses.
13 CFR Part 121
Loan programs--business, Reporting and recordkeeping requirements,
Small businesses.
For the reasons stated in the preamble, SBA proposes to amend 13
CFR parts 120 and 121 as follows:
PART 120--BUSINESS LOANS
0
1. The authority citation for 13 CFR part 120 continues to read as
follows:
Authority: 15 U.S.C. 634(b)(6), (b)(7), (b)(14), (h), and note,
636(a), (h) and (m), and note, 636m, 650, 657t, and note, 657u, and
note, 687(f), 696(3), and (7), and note, and 697, 697a and e, and
note; Public Law 116-260, 134 Stat. 1182.
0
2. Amend Sec. 120.130 by revising paragraph (g) to read as follows:
Sec. 120.130 Restrictions on uses of proceeds.
* * * * *
(g) Any use restricted by Sec. Sec. 120.201 and 120.884 (specific
to 7(a) loans and 504 loans respectively).
0
3. Revise Sec. 120.150 to read as follows:
Sec. 120.150 What are SBA's lending criteria?
The applicant (including an Operating Company) must be
creditworthy. Loans must be so sound as to reasonably assure repayment.
Lenders and CDCs must use appropriate and prudent generally acceptable
commercial credit analysis processes and procedures consistent with
those used for their similarly-sized, non-SBA guaranteed commercial
loans. Lenders, CDCs, and SBA may use a business credit scoring model.
When approving direct or guaranteed loans, Lenders, CDCs, and SBA may
consider (as applicable) the following criteria: credit score or credit
history of the applicant (and the Operating Company, if applicable),
its Associates and any guarantors; the earnings or cashflow of
applicant; or where applicable any equity or collateral of the
applicant.
Sec. 120.160 [Amended]
0
4. Amend Sec. 120.160(c) by adding the phrase ``for loans greater than
$150,000,'' after the words ``SBA requires hazard insurance.''
0
5. Amend Sec. 120.193 by adding the words ``or designee(s),'' after
the words ``Director, Office of Financial Assistance (D/FA)'' and by
adding two sentences at the end of the section to read as follows:
Sec. 120.193 Reconsideration after denial.
* * * If the reconsideration is denied, a second and final
reconsideration may be considered by the Director, Office of Financial
Assistance (D/FA) or designee(s), whose decision is final. The SBA
Administrator, solely within the Administrator's discretion, may choose
to review the matter and make the final decision. Such discretionary
authority of the Administrator does not create additional rights of
appeal on the part of an applicant not otherwise specified in SBA
regulations.
0
6. Revise Sec. 120.202 to read as follows:
Sec. 120.202 Loans for changes of ownership.
Notwithstanding Sec. 120.130(a), a Borrower may use 7(a) loan
proceeds to purchase a portion of or the entirety of an owner's
interest in a business, or a partial or full purchase of a business
itself.
PART 121--SMALL BUSINESS SIZE REGULATIONS
0
7. The authority citation for 13 CFR part 121 is revised to read as
follows:
Authority: 15 U.S.C. 632, 634(b)(6), 636(a)(36), 662, 694a(9),
and 9012.
0
8. Amend Sec. 121.301 by adding introductory text and revising
paragraph (f) to read as follows:
Sec. 121.301 What size standards and affiliation principles are
applicable to financial assistance programs?
The Small Business Act defines a small business concern as one
which is independently owned and operated, and which is not dominant in
its field of operation. SBA interprets this statutory definition to
require, in certain circumstances, the inclusion of other entities
(``Affiliates'') owned by the applicant or an owner of the applicant in
determining the size of the applicant.
* * * * *
(f) Any of the circumstances described below establishes
affiliation for applicants of SBA's Business Loan, Disaster Loan, and
Surety Bond Programs. For this rule, the Business Loan Programs consist
of the 7(a) Loan Program (Direct and Guaranteed Loans), the Microloan
Program, the Intermediary Lending Pilot Program, and the Development
Company Loan Program (``504 Loan Program''). The Disaster Loan Programs
consist of Physical Disaster Business Loans, Economic Injury Disaster
Loans, Military Reservist Economic Injury Disaster Loans, and Immediate
Disaster Assistance Program loans. The following principles apply for
the Business Loan, Disaster Loan, and Surety Bond Guarantee Programs:
(1) Ownership. (i) When the Applicant owns more than 50 percent of
another business, the Applicant and the other business are affiliated.
(ii) When a business owns more than 50 percent of an Applicant, the
business
[[Page 64734]]
that owns the Applicant is affiliated with the Applicant. Additionally,
if the business entity owner that owns more than 50 percent of the
Applicant also owns more than 50 percent of another business that
operates in the same 3-digit NAICS subsector as the Applicant, they are
all affiliated.
(iii) When an individual owns more than 50 percent of the Applicant
and the individual also owns more than 50 percent of another business
entity that operates in the same 3-digit NAICS subsector as the
Applicant, the Applicant and the individual owner's other business
entity are affiliated.
(iv) When the Applicant does not have an owner that owns more than
50 percent of the Applicant, if an owner of 20 percent or more of the
Applicant is a business that operates in the same 3-digit NAICS
subsector as the Applicant, the Applicant and the owner are affiliated.
(v) When the Applicant does not have an owner that owns more than
50 percent of the Applicant, if an owner of 20 percent or more of the
Applicant also owns more than 50 percent of another business entity
that operates in the same 3-digit NAICS subsector as the Applicant, the
Applicant and the owner's other business entity are affiliated.
(vi) Ownership interests of spouses and minor children must be
combined when determining amount of ownership interest.
(vii) When determining the percentage of ownership that an
individual owns in a business, SBA considers the pro rata beneficial
ownership of entities. For example, John Smith, Jane Doe, and Jane Doe,
Inc., each own an interest in the Applicant. Jane Doe owns 15 percent
of the Applicant, and she also owns 100 percent of Jane Doe, Inc. Jane
Doe, Inc. owns 50 percent of the Applicant. SBA considers Jane Doe to
own 65 percent of the Applicant.
(2) Stock options, convertible securities, and agreements to merge.
(i) SBA considers stock options, convertible securities, and agreements
to merge (including agreements in principle) to have a present effect
on the ownership of the entity. SBA treats such options, convertible
securities, and agreements as though the rights granted have been
exercised.
(ii) Agreements to open or continue negotiations towards the
possibility of a merger or a sale of stock at some later date are not
considered ``agreements in principle'' and are thus not given present
effect.
(iii) Options, convertible securities, and agreements that are
subject to conditions precedent which are incapable of fulfillment,
speculative, conjectural, or unenforceable under state or Federal law,
or where the probability of the transaction (or exercise of the rights)
occurring is shown to be extremely remote, are not given present
effect.
(iv) SBA will not give present effect to individuals', concerns',
or other entities' ability to divest all or part of their ownership
interest to avoid a finding of affiliation.
(3) Determining the concern's size. In determining the concern's
size, SBA counts the receipts, employees (see Sec. 121.201), or the
alternate size standard (if applicable) of the concern whose size is at
issue and all of its domestic and foreign affiliates, regardless of
whether the affiliates are organized for profit.
(4) Exceptions to affiliation. For exceptions to affiliation, see
Sec. 121.103(b).
* * * * *
Isabella Casillas Guzman,
Administrator.
[FR Doc. 2022-23167 Filed 10-25-22; 8:45 am]
BILLING CODE 8026-03-P
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</html>Indexed from Federal Register on October 26, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.