Expansion & Modifications To The existing 7(a) & Economic Injury Disaster Loan Programs
As you likely know, Congress just passed the Coronavirus Aid, Relief, and Economic Security, or “CARES Act” to assist businesses in distress during this difficult time in our Country. While the act is wide-ranging, concerning itself with many different types of relief, it specifically provides for loans guaranteed by the Small Business Administration (SBA). The act expands and modifies the existing 7(a) and Economic Injury Disaster Loan (EIDL) programs. Some of the major components of the 7(a) program are:
- Expansion of SBA’s 7(a) Loan Program to Support New “Paycheck Protection Program” Loans. The SBA’s existing 7(a) program will see:
- Increase in maximum loan amount to $10 million.
- Allowable uses expanded to include:
- Payroll support (including paid sick or medical leave);
- Employee salaries;
- Mortgage, rent and utility payments;
- Insurance premiums; and
- Other debt obligations.
- Loan Forgiveness. Certain borrowers would be eligible for loan forgiveness equal to the amount spent during an eight-week period after the origination date of the loan on:
- Payroll costs;
- Interest payment on any mortgage incurred before Feb. 15, 2020;
- Rent on any lease in force before Feb. 15, 2020; and
- Utilities for which service began before Feb. 15, 2020.
The amount forgiven would be reduced in proportion to any reduction in employees retained compared to the prior year and to the reduction in pay of any employee beyond 25% of prior year compensation.
- Special Terms for SBA Loans.
- No personal or collateral guarantee will be required.
- The eligible recipient does not have to certify that it is unable to obtain credit elsewhere.
- Eligible borrowers must make a good faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by COVID-19; that funds will be used for a permitted purpose; and that they are not receiving funds from another SBA program for the same uses.
- Maximum term of loan is 10 years.
- Interest rate cannot exceed 4%, but interest payments are completely deferred for 1 year.
- No prepayment penalty.
The CARES Act program covers business with 500 or fewer employees, unless the covered industry’s SBA size standard allows more than 500 employees, which were operational on Feb. 15, 2020. The size standards are tested on an affiliate basis—combined with all businesses under common control (50% ownership or contractual control)—counting on an aggregate basis towards the size test, except for hospitality and restaurant businesses, franchises, and recipients of Small Business Investment Company (SBIC) investment.
This means that the 500-employee threshold is measured for the certain excepted businesses in the hospitality and restaurant business, franchises, and recipients of SBIC loans on a location-by-location basis. For instance, a hotelier with more than 500 employees nationwide may seek loans for individual properties. Consultation with an attorney to determine how a loan request can be structured to ensure eligibility may be key.
Following a detailed application, the loan will be eligible for partial forgiveness in an amount (not to exceed the principal amount of the loan) equal to the sum of payroll costs, rent and utilities expenses, and interest payments on mortgages so long as any such lease, mortgage, or utility was in service prior to February 15, 2020 and, in each case, paid during the eight-week period commencing on the date of the loan. In other words, forgiveness will be limited to the actual payment of certain types of permitted expenses actually incurred before the covered period started and paid after the loan was secured. Rental payment under a lease in effect as of January 1, 2020, would be eligible for forgiveness while rental payment under a lease effective as of March 15, 2020, would not. Eligible payroll costs do not include compensation above $100,000.
Loans will be made by lenders who are participants in the SBA’s Section 7(a) program and those lenders will also decide whether to accept a borrower’s application for forgiveness. Such decision must be made within 60 days of receipt of the application for forgiveness. Not later than 90 days after the loan forgiveness amount has been agreed by the lender, the SBA is authorized to reimburse the lender directly for the principal amount of any forgiven debt, plus interest accrued through the date of repayment.
The amount of any loan forgiveness will be reduced by meaningful reductions in employee wages (more than 25% for any employee) or layoffs of employees during the covered period in accordance with the terms of the program. Borrowers that rehire workers previously laid off will not be penalized for having reduced payroll at the beginning of the period. There will not be cancellation of indebtedness (“COD”) income recognized upon forgiveness for tax purposes.
Any loan amount not forgiven at the end of one year is carried forward as an ongoing loan with a maximum term of 10 years and a maximum interest rate of 4%.
Detailed accounting and complete and accurate record keeping will be vital to taking advantage of these provisions.
Maximum Amount of Loan
The maximum loan amount is the lesser of $10 million or the product obtained by multiplying average total monthly payments for payroll costs during the 1-year period before the loan is made by 2.5. So, if the loan was made on April 1, 2020, and average monthly payroll costs for the period April 1, 2019, to April 1, 2020, were $1,500,000, the maximum loan amount would be $3,750,000. The loan can also include the outstanding amount of a loan made under the SBA’s Disaster Loan Program between January 31, 2020, and the date on which such loan may be refinanced as part of this new program.
Under the CARES Act, the loan period for this program would begin on February 15, 2020, and end on December 31, 2020, during which time any application must be submitted. The program would cover businesses with fewer than 500 employees (unless the covered industry’s SBA size standard allows more than 500 employees).
Government guarantee of 7(a) loans would be increased to 100% through December 31, 2020. After that date, guarantee percentages would return to 75% for loans exceeding $150,000 and 85% for loans equal to or less than $150,000.
Allowance for New Lenders
The CARES Act allows the Department of Treasury to establish a process by which lending institutions that are not currently authorized to offer SBA loans will be able to participate during the declared national emergency.
Subsidy/Deferment for Existing Loans
The SBA will pay the principal, interest and any associated fees that are owed on certain existing 7(a) loans for a six-month period starting on the next payment due date. Loans already currently in deferment would include an additional six months of payment by the SBA beginning with the next payment. Loans made during this period until six months after the enactment of the legislation would also qualify for six months of deferral payment by the SBA. This does not apply for new “Paycheck Protection Program” loans made under the CARES Act.
Existing SBA Disaster Loan Program (EIDL)
The SBA’s existing disaster assistance loans were made a part of Congress’s second emergency bill, the Coronavirus Preparedness and Response Supplemental Appropriations Act signed into law on March 6, 2020. Under that law, the SBA expanded the ways in which businesses could apply for an Economic Injury Disaster Loan (EIDL).
Importantly, under the CARES Act, a borrower that receives a 7(a) loan for employee salaries, payroll support, mortgage payments and/or other debt obligations would not be able to receive an EIDL for the same purpose, or co-mingle funds from another loan for the same purpose.
The EIDL program does have the benefit of establishing an emergency grant to allow an eligible entity to request an advance on the EIDL of up to $10,000. An applicant would not be required to repay such an advance payment, even if it is subsequently denied an EIDL.
The programs discussed above, and other assistance programs being established throughout this pandemic, will have varying benefits and eligibility requirements. A business should carefully assess which of the new federal programs is most advantageous before applying and assess how best to plan for, apply to, and manage any loans received for their maximum benefit.
Other CARES Act Provisions Specific to Lenders
The CARES Act Suspends some bank regulations and FASB and GAAP rules to allow lenders to deal more effectively with immediate loan repayment problems caused by Covid-19.
- Banks are not required to write-down loans that are suspected of being impaired.
- Banks now have more latitude in restructuring/modifying loans to assist borrowers in trouble.
- The Comptroller of the Currency can waive legal lending limits to assist borrowers in managing their debt as it relates to Covid-19.
*Based upon the excellent research and publications by the Bryan Cave Leighton Paisner law firm.
Burke Advisory Services
March 30, 2020
Kevin Burke is a member of the Turnaround Management Association and a Certified Turnaround Professional. A graduate of the Villanova School of Business, he has over 35 years of experience in banking and executive management. His management consulting practice is located in Troy, Michigan.