504 Debt Refinancing

SUPPLEMENTARY INFORMATION:

I. Background Information

The 504 Loan Program is an SBA financing program authorized under title V of the Small Business Investment Act of 1958, 15 U.S.C. 695 et seq. The core mission of the 504 Loan Program is to provide long-term financing to small businesses for the purchase or improvement of land, buildings, and major equipment, in an effort to facilitate the creation or retention of jobs and local economic development. Under the 504 Loan Program, loans are made to small business applicants by Certified Development Companies (“CDCs”), which are certified and regulated by SBA to promote economic development within their community. In general, a project in the 504 Loan Program (a “504 Project”) includes: A loan obtained from a private sector lender with a senior lien covering at least 50 percent of the project cost; a loan obtained from a CDC (a “504 Loan”) with a junior lien covering up to 40 percent of the total cost (backed by a 100 percent SBA-guaranteed debenture); and a contribution from the Borrower of at least 10 percent equity.

In addition, the 504 Loan Program may be used to refinance debt under two options authorized under section 502(7)(B) and (C) of the Small Business Investment Act of 1958. First, if a 504 Project involves the expansion of the small business, any amount of existing indebtedness that does not exceed 100 percent of the project cost of the expansion may be refinanced and added to the project's cost (Debt Refinancing with Expansion) under the conditions set forth in section 502(7)(B) and the implementing regulations. See13 CFR 120.882(e) and (f). Second, debt refinancing is available for a 504 Project that does not involve the expansion of the small business under the requirements set forth in section 502(7)(C) and 13 CFR 120.882(g) (Debt Refinancing without Expansion).

On July 29, 2021, SBA published in the Federal Register an interim final rule implementing section 328(a) of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), enacted December 27, 2020, Public Law 116-260, which revised the conditions and requirements for refinancing 504 loan debt (“Debt Refinancing in the 504 Loan Program interim final rule” or “interim final rule”). 86 FR 40775 (July 29, 2021). SBA subsequently issued a final rule on October 12, 2023, finalizing the interim final rule and implementation of section 328 of the Economic Aid Act (“Debt Refinancing in the 504 Loan Program final rule” or “final rule”). 88 FR 70580 (October 12, 2023).

With the prior rulemaking the Agency included statutorily required mandatory changes to the 504 loan program, with one omission, as the statutory change limiting the loan dollar volume of 504 refinancing loans without expansion to 50% of the CDC's prior portfolio, as required by section 328(a)(2)(A) of the Economic Aid Act, was not included. In addition, during the prior rulemaking the National Associate of Development Companies (NADCO), a 504 Loan Program trade association, along with many of its member CDCs, requested additional changes to the 504 loan program. Since these changes went beyond those mandated by the Economic Aid Act, they were not implemented at the time since the Agency's objective was to implement the statutory changes directly and expeditiously without variation. Some of the changes recommended by the trade association required careful consideration by each impacted SBA office, had the potential for risk shifting in the 504 portfolio, had a potential impact on other SBA programs such as the 7(a) program, or had a potential for impact on the 504 subsidy rate and consequently were held for future rule making. The comments were nonetheless consistent with lender round table feedback from three major lender conferences.

Commenters, requested that SBA: increase eligibility for 504 debt refinance with expansion and 504 debt refinance without expansion; update the eligibility standards for more flexibility; remove requirements that are not required by statute and which create an additional barrier to debt restructuring and relief for 504 small business borrowers; raise the loan to value requirement on debt refinancing without expansion projects; align the “substantially all” standard for 504 debt refinancing with expansion with the 504 debt refinancing without expansion standard; and eliminate the 10% substantial benefit test on 504 debt refinancing with expansion and 504 debt refinancing without expansion on refinancing other government debt.

Congress' long-established policy is that SBA stimulate and supplement the flow of long-term loan funds which small business concerns need for the sound financing of their business operations and for their growth, expansion, and modernization, including with the refinancing of existing loan debt. 15 U.S.C. 661. Businesses are facing increasing operating costs due to inflation, global supply chain challenges, and increases in building costs and supplies which are above pre-pandemic levels. The impact of multiple Federal Reserve interest rate increases from March 2022 to February 2024 has prompted a request for expedient SBA action on behalf of small business borrowers. The 504 loan program has a long-term fixed interest rate for 40% of the project to help small businesses refinance conventional loans or government based programs, which are generally based on a variable rate. This results in significant cost savings for the small business borrower and assists small businesses with managing costs by providing a predictable expense with a fixed interest rate.

Further, as the interim final rule was released July 29, 2021, and as the final rule was released October 12, 2023, SBA could not have anticipated the impact on policy of the Federal Reserve interest rate policy during the prior rulemaking. Since the publication of the Debt Refinancing in the 504 Loan Program final rule, SBA's Office of Financial Assistance (OFA) has received input on the impact of the rising interest rate environment on 504 debt refinancing. For example, SBA received feedback on the difficulty of SBA applicants in meeting the 10% substantial benefit test to borrowers, and CDCs have asked for a revision of this standard as it was not required in statute and was adopted through regulations.

As described in the section-by-section analysis below, SBA is issuing this direct final rule to correct the omission described above and to implement changes to 504 debt refinancing in response to public comments provided during the prior rulemaking and industry input both before and following the prior rulemaking.

II. Justification for Direct Final Rule

In general, SBA publishes a rule for public comment before issuing a final rule, in accordance with the Administrative Procedure Act. 5 U.S.C. 553. The Administrative Procedure Act provides an exception to this standard rulemaking process, however, when an agency finds good cause to adopt a rule without prior public participation. 5 U.S.C. 553(b)(3)(B). The good cause requirement is satisfied when prior public participation is impracticable, unnecessary, or contrary to the public interest. SBA is publishing this rule as a direct final rule because public participation is unnecessary. SBA views this as a non-controversial administrative action because all technical corrections and updates are consistent with public comments received throughout the previous rulemaking process. This rule will be effective on the date shown in the DATES section unless SBA receives significant adverse comment on or before the deadline for comments. Significant adverse comments are comments that provide strong justifications why the rule should not be adopted or for changing the rule. SBA does not expect to receive any significant adverse comments because these technical corrections and updates are consistent with broad stakeholder comments received during the prior previous rulemaking process. Further, because some of the changes in this rule are prescribed by statute, SBA does not expect significant adverse comments.

If SBA receives significant adverse comment, SBA will publish a document in the Federal Register withdrawing this rule before the effective date. If SBA receives no significant adverse comments, the rule will be effective 45 days after publication without further notice.

III. Section-by-Section Analysis

A. Delete 13 CFR 120.882(g)(10) To Remove the 50% Cap for Debt Refinancing Without Expansion in Alignment With the Economic Aid Act

Subsequent to the publication of the Debt Refinancing in the 504 Loan Program final rule SBA identified a drafting omission that must be corrected to ensure the corresponding regulation aligns with the Economic Aid Act. Section 328(a) of the Economic Aid Act had repealed section 521(a) of title V of division E of the Consolidated Appropriations Act of 2016. Section 521(a), in part, limited a CDC's financings so that in any fiscal year no more than 50 percent of the CDC's financings were for debt refinancing not involving expansion, a requirement implemented by SBA regulations at 13 CFR 120.882(g)(10). Consequently, the Debt Refinancing in the 504 Loan Program final rule should have deleted the regulation at 13 CFR 120.882(g)(10).

SBA has included in this direct final rule the correction and is removing 50% cap for debt refinancing without expansion to align with the Economic Aid Act, thereby removing the current inconsistency between Agency regulations and the statute. This change will provide certainty to CDCs that their debt refinancing loans are no longer capped at 50% of the total dollar amount of the CDC's 504 loans approved, thereby increasing debt refinancing opportunities for small business concerns.

B. Update 13 CFR 120.882(g)(6) To Increase the Percentage of Qualified Debt in Projects Including Eligible Business Expenses From 85% to 90% and Remove the 20% Cap on Eligible Businesses Expenses

Currently, if an application for a 504 debt refinancing without expansion project includes a request to finance Eligible Business Expenses (as described in 13 CFR 120.882(g)(6)(ii)), the portion of the refinancing project provided by the 504 loan and the third party loan may be no more than 85% of the fair market value of the fixed assets that will serve as collateral and the Borrower may receive no more than 20% of the fair market value of the eligible fixed assets securing the debt to be refinanced for Eligible Business Expenses. SBA is removing these restrictions in regulation in order to expand eligibility for more small businesses to access debt refinancing under the 504 loan program. SBA will review comments received in response to this direct final rule and will consider further policy changes are needed.

C. Adding Consistency to the Standard for “Substantially All” Between Refinancing Without Expansion and Refinancing With Expansion

Under current regulations, one of the conditions of a 504 debt refinancing with expansion project is that substantially all (85% or more) of the proceeds of the indebtedness were used to acquire land, including a building situated on that land, to construct a building on that land, or to purchase equipment. The previous 504 debt refinancing rulemaking modified the 504 debt refinancing without expansion “substantially all” standard in the Qualified Debt definition by lowering the threshold from 85% to 75%. The effect was that this lowered standard only applied to 504 debt refinancing without expansion because the term “Qualified Debt” is only used in the context of 504 debt refinancing without expansion and not 504 debt refinancing with expansion.

SBA received input from NADCO and during lender round tables that this inconsistency of 75% for 504 debt refinancing without expansion and 85% for 504 debt refinancing with expansion is confusing and that it would be helpful to have a consistent standard between the debt refinancing with expansion and debt refinancing without expansion options for CDCs, third party lenders, and small businesses seeking 504 loan program assistance. Based on public comments received, SBA is making the “substantially all” standard consistent between the two programs by revising § 120.882(e)(1) to lower the “substantially all” standard from 85% to 75% for 504 debt refinancing with expansion. SBA will review comments received in response to this direct final rule and will consider further policy changes are needed to further expand the standard.

D. Allowing Other Secured Debt To Be Included as an Eligible Business Expense

Under current regulations, a debt refinancing without expansion project may include a request to finance eligible business expenses, which are limited to the operating expenses of the business. Debt is generally not included as an eligible business expense, except for certain types of unsecured debt. On occasion SBA Applicants have debt that has been secured by the same Eligible Fixed Assets securing the qualified debt that is the subject of the 504 debt refinancing project (“Other Secured Debt”). Under current regulations Other Secured Debt may not be part of the 504 debt refinancing project. As a result, the borrower, even with 504 financing, may be subject to debt and liens that are not in the best risk portfolio interest of the Agency. Including Other Secured Debt as an Eligible Business Expense is in alignment with 504 loan program goals, and the flexibility to include Other Secured Debt would further assist the small business in restructuring its outstanding debt. Even so, SBA will not consider Other Secured Debt that was incurred for capital expenditures as an Eligible Business Expense because such expenditures are not the day-to-day expenses of a business and SBA does not believe Congress intended that such expenditures be included as an Eligible Business Expense. Further, while a secured business line of credit may be an Eligible Business Expense, such Other Secured Debt will only be eligible as part of a 504 debt refinance without expansion financing provided any existing liens are subordinated to the 504 loan.

E. Revising 13 CFR 120.882(e)(5) and (g)(3)(iii) the Substantial Benefit Test for Government Guaranteed Debt for 504 Refinancing With and Without Expansion To Remove the 10% Standard

Under current regulations at 13 CFR 120.882(e)(5) and (g)(3)(iii), 504 debt refinancing must provide a “substantial benefit” to the borrower. For purposes of 504 debt refinancing a “substantial benefit” means that the portion of the new installment amount attributable to the debt being refinanced must be at least 10 percent less than the existing installment amount. In its public comments for the prior rulemaking, NADCO noted that because of the high interest rate environment and the large number of interest rate increases in recent year, the 10% substantial benefit test is overly burdensome for the 504 small business borrower. NADCO requested that SBA remove this test to provide the small business borrower the maximum opportunity to respond to market conditions.

SBA's concerns about portfolio risk for both the 504 and 7(a) programs led SBA to adopt the 10% substantial benefit test for the 504 loan program to provide parity with the 7(a) program's 10% substantial benefit test. There are substantial differences, however, between the programs that would obviate the necessity to anchor the 504 loan program to the 7(a) loan program's 10% substantial benefit test. For example, SBA's motivation for adopting a 10% substantial benefit test in 7(a) stemmed from the concern with using limited 7(a) program authority for refinancing, especially for other 7(a) loans already considered to be on reasonable terms, and the concern over the risk of considerable 7(a) secondary market distortions. Meanwhile, the 504 Loan Program has ample authority for debt refinancing and adding restrictions on 504 refinancing at the same level of 7(a) refinancing restrictions would be overly burdensome on the 504 small business borrower. The result is that many small businesses are prevented from refinancing into a more favorable longer term fixed-rate product and must remain with their variable rate loan in a rising rate environment.

SBA is therefore revising 13 CFR 120.882(e)(5) and (g)(3)(iii) to remove the 10% substantial benefit test for both debt refinancing with expansion and debt refinancing without expansion, while maintaining the requirement that the 504 small business borrowers must have documented benefit in the restructuring of debt.

Review Act (5 U.S.C. 801-808), Paperwork Reduction Act (44 U.S.C., Ch. 35), and the Regulatory Flexibility Act (5 U.S.C. 601-612)

Executive Order 12866

The Office of Management and Budget (OMB) has determined that this rule does not constitutes a “significant regulatory action” for purposes of Executive Orders 12866. This direct final rule implements specific statutory provisions in section 328(a)(2)(A) and implements additional changes to debt refinancing in SBA's 504 loan program.

As shown in Tables 1A and 1B below, during the five-year period spanning fiscal year (FY) 2018 and FY 2024 (year-to-date (YTD) through May), a total of 47,252 504 loans were approved for a total gross approval amount as of May 31, 2024, of $43,003,577,000. In addition, during the past six fiscal years, SBA approved an average of 235 debt refinance with expansion loans per year with an average annual dollar volume of $305,542,333 and approved an average of 441 debt refinance without expansion loans per year with an average annual dollar volume of $470,209,333. In 2020, the Economic Aid Act increased the amount of existing indebtedness eligible for a debt refinance with expansion project from 50 percent of the project cost to 100 percent of the project cost which appears to have impacted loan size. The tables are arranged in order to convey the data while staying within the margin parameters of the Federal Register notice guidelines and are an update to the data provided in the 504 Debt Refinancing final rule published October 12, 2023. As this direct final rule, in part, is intended to correct drafting errors and provide eligibility clarifications in the prior final rule, SBA has updated data on through May 31, 2024, and included data reported through September 30, 2023 (last full fiscal year), in the final rule.