504 LIQUIDATION BEST PRACTICES

Hollis Carter, 23 year veteran with SBA and a Hilco strategic alliance partner, joins Steve Katz to discuss 504 Liquidation best practices.

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Steve Katz  0:08  
Hello again and welcome to the Hilco Global Smarter Perspective podcast series. I'm your host Steve Katz. Today, we're pleased to have Hollis Carter with us again. Hollis is a 23 year veteran with SBA and a Hilco strategic alliance partner. And our discussion today will focus on 504 Liquidation best practices. We're going to talk about several things. First of all, we'll address how to make timely and appropriate debenture purchase decisions and define a CDC's basic liquidation responsibilities. Then we'll talk about how to prepare effective and realistic liquidation plans and explore liquidation appraisals versus liquidation broker price opinions. And finally, Hollis will take us through the details of how to construct a realistic protective bid analysis. So quite a bit to cover today but we'll keep it moving and I'm sure you'll find it very informative. Just a little bit of quick background Hilco Real Estate is a unit of Hilco Global providing strategic advisory and transactional services to minimize cost and maximize the value of real estate assets for both healthy businesses and businesses in transition. Hilco has been involved in repositioning more than 35,000 leases and in the disposition of over 200 million square feet of retail, industrial and office properties since it was founded over 25 years ago. With that said, Hollis, welcome back to the podcast.

Hollis Carter  1:21  
Thanks, Steve. It's great to be here again.

Steve Katz  1:22  
Yeah, it's great to have you.  All right Hollis can you start us off today by discussing why or when it becomes necessary for the SBA to accelerate and purchase a debenture? 

Hollis Carter  1:32  
Sure, Steve. The short answer to your question is that payment default, or when a borrower reaches a point where it's pretty obvious the business has suffered a permanent reduction in cash flow that will not support 504 Loan payments. So when a business gets to that point, you can most all cases you're going to have to ask SBA to repurchase the debenture. But I want to talk about several factors that might impact your decision whether or not to purchase the debenture. Number one, can the problem be effectively addressed with a deferment? If that's the case clearly, you should go ahead and defer rather than purchase. Number two, is the catch-up plan feasible or make those payments when the deferment ends? Do we have current financials? What is the status of the TPL Loan? The third-party lender loan? Have you talked with them? Is their loan performing? Is the business viable? Is the business closed? Have to check on the status of property taxes and insurance. Are they up to date on those? Is the borrower cooperative and acting in good faith? Have you sent a strong past due letter that includes impact of the Treasury Offset Program and the possibility of administrative wage garnishment as possible consequences? Are you considering potential future servicing fees in the decision? And I would digress here a little bit to say if you are that's a problem. You really should not consider potential futures servicing fees in your purchase decision that should entirely be based on the merits if that business is in a position to survive and make the payments. If they're not, then you should purchase regardless of the potential servicing fees. And that leads right into that this decision really bottom line has to be based on what's in the best interest of the SBA and the 504 program. And finally, a really major factor in the decision is when is that next semiannual prepayment date. If that is coming up right away, you've got to make this decision quickly. If it's down the road a few months, you've got the luxury of time where you maybe could defer just for a few months and then revisit the issue later. Finally, you've got to make these purchase decisions at least one month prior to the semiannual date in order to give SBA time to make the deadline of Wells Fargo in getting the purchase processed. 

Steve Katz  3:36  
Okay, great starting point. Good details. Thanks so much. Now I ask can you give us some specific examples of when a debenture purchase becomes necessary?

Hollis Carter  3:46  
Sure, I can give you several examples of when it's necessary. And the first two I'm going to talk about are probably the most common causes of SBA purchasing a debenture. And number one, the most obvious is 504 Loan of the borrower. Other real common reason or example is when the third-party lender sends out what SBA calls a 60-day letter advising the CDC and SBA of their intent to foreclose. A third-party lender has to give SBA at least 60 days notice before they foreclose. So those are the two most common things. Occasionally that the third party lender won't do that and we'll just out of the blue receive their notice of foreclosure. So that obviously would require immediate purchase. A short sale, if you get a borrower that just obviously can't make the payments, can't meet the payment schedule with the debenture, but they have got a buyer for a short sale, that would be an example of where purchase would be necessary. Bankruptcy of the borrower or of the eligible passive company or the holding company that owns the real estate and sometimes the guarantor with the guarantor, it may be necessary may not be necessary. If the collateral is abandoned, that pretty clear cut a purchase is required if the receiver is appointed, or if there's a strategic default. Maybe in another podcast, we can talk about that in detail. 

Steve Katz  5:03  
Sure. Yeah, that would be great. All right. What about the other side of that? What are some examples of when a debenture purchase may not be appropriate for a problem credit?

Hollis Carter  5:11  
Well, there are definitely some cases where it may be appropriate to hold off on the debenture purchase and allow the CDC to continue to work with the borrower. Really important thing about this, before you do this, you really need to closely coordinate that with SBA with their liquidation division and third-party lender in the loop as well. It's recommended that the CDC get written approval from SBA before they delay a debenture purchase that ordinarily would be necessary, but you should get SBA's approval before you do this. And it should be due to some pretty specific and special circumstances. And if you don't document all that you could run into problems if that loan is selected for an SBA, OCRM or the Office of Credit Risk Management. So that kind of leads to what are the justification for delaying a purchase? Number one, and this is probably the most common reason and that is if the loan is over 60 days delinquent, in other words, qualified to be purchased or should be repurchased, but it's fully secured and in the process of being assumed or paid off. For example, sales contract is pending, there's a signed contract, a refinancing that you've verified is pending, those could be some reasons to hold off. But again, you do have to have evidence. You've got to have a copy of that signed contract, you've got to have a commitment for the refinancing and that sales contract has to be for an amount sufficient to pay the 504 Loan in full. Another example would be if the borrower provides evidence that the loan will be brought current by date certain. In other words, they can give you evidence if say they've got an investor coming in, and you've got some type of verification that that investor has the wherewithal to inject whatever capital is that they're proposing that would bring the loan current. And what I touched on a moment ago is if the semiannual date is some months into the future, and the borrower is working to pay off or bring the loan current, you could delay that purchase until the next semiannual date. But again, as I said earlier, that you have to notify SBA at least 30 days prior to that semiannual date.

Steve Katz  7:16  
Okay, what else? I'm sure there's quite a bit more information that you have. What else should the audience know about debenture purchases?

Hollis Carter  7:24  
Well, to wrap up on debenture purchases, they're really the way I like to put it as several must, if you will, things that the CDC really needs to be aware of and must do if they do accelerate in purchasing a debenture. Number one, if the loan is accelerated and classified in liquidation by the CDC or SBA, the CDC is required to immediately purchase that debenture. The semiannual date as I mentioned previously, that prepayment date is key and must be considered in all problem long servicing situations. What I'm saying there is you don't want to let the semiannual date sneak up on you and miss it. And basically, the way the SBA program works is the SBA, since they can only be prepaid or purchased every six months the SBA would have to advance six months worth of interest to the investor. So that would contribute to any potential loss that cash advance that SBA would have to make. Debentures must be purchased timely for the same reason that is prior to the optimal semiannual day. As I said, if not it can cost SBA, the taxpayer, and the 504 program, big dollars and credibility of the CDC. Timely debenture purchases also an item for OCRM audits so you must be aware of that and if you don't handle it properly, you could be written up in an OCRM audit.  All debenture purchases and related requests must be emailed to the appropriate servicing centers liquidation boxes a center in Fresno that's fsc.504liquidations@sba.gov. Oddly enough Little Rock's email address is slightly different lrsc.504liquidation@sba.gov. But again, as I said earlier, and I want to stress this the debenture purchases or cancellation of purchases must be scheduled prior to the 11th business day of the month. SBA sends a list up for purchase every month and if you don't get it in by the 11th, they're not going to purchase it and that that's pretty much a hard and fast deadline. There are also several implications of a purchase that the CDCs need to be aware of. In other words, things that actually impact the loan. Number one, the central servicing agent servicing terminates, that is Wells Fargo who is the servicing agent at this time, they would no longer be responsible for servicing the loan that would shift over to the CDC and SBA actually would do the loan accounting. All servicing fees for the CDC are eliminated. The monthly payment on the note is reduced by those servicing fees. It becomes only a principal and interest payment at that point, any prepayment premiums or penalties are eliminated once it's purchased. The big advantage of a debenture purchase though is that the terms of the note can then be modified substantially. Very restricted on what you can do with a 504 Loan prior to purchase, the only thing you can do to assist that borrower is to defer payments. So once the loan is purchased, SBA has the ability to make all kinds of modifications if justified to interest rates, monthly payment amounts, the term of the loan, etc, to provide some relief. And the SBA loan number changes just the last three digits so they can differentiate between a purchased loan but also still keep the historical record of the loan prior to purchase. And then finally, all loan payments and liquidation recoveries after purchase are admitted to SBA and not to the central servicing agent that is Wells Fargo.

Steve Katz  10:54  
Got it? Okay. Wow.  A lot of information there, but very informative. Thanks. All right. Let's move on. What if I can ask you are the CDC's liquidation responsibilities after the debenture is purchased?

Hollis Carter  11:07  
That's a great question, Steve. I mean, basically, SBA, the servicing centers are very thinly staffed, they have a liquidation division, but there's absolutely no way they've got the resources to handle the liquidation process themselves without the CDC's assistance. So basically, first and foremost, the CDC at that point would act as SBA's eyes, ears, and voice throughout the liquidation process. The CDC would be on the ground, the primary contact to the borrower, and the voice through which SBA would speak. CDC is responsible for preparing and submitting a liquidation plan within 30 calendar days of debenture purchase. So you have to go in and get that in timely. The CDC is also required to go ahead and order an independent broker's price opinion or an appraisal on behalf of SBA.  They would be expected to determine and communicate the status of the party lender loan and what the third-party loans position might be regarding any kind of workout that could be formulated. CDC would continue as the primary contact with the borrower and the third-party lender to facilitate good, clear communications throughout the liquidation process. And the CDC would be expected to prepare a protective bid analysis of what SBAs collateral position is in the event of for sale, and in that analysis, they would be expected to make a bid or no-bid recommendation in the event that the third-party lender decided to move to foreclosure. That's about it. But those are the biggest responsibilities that the CDC has in terms of working with the SBA liquidation division to liquidate a loan.

Steve Katz  12:52  
So you can probably guess my next question based on that is what are the SBA's expectations of CDCs in regards to liquidation plans?

Hollis Carter  13:01  
Well, all CDCs if handling a liquidation should prepare and submit a liquidation plan to the servicing center again within 30 calendar days. They should also complete the status information on both the 504 and TPL Loans including related loans. They should update the status of both the 504 and the third-party lender loan. The CDC should provide a complete explanation of the situation including any potential workout and causes for the business failure. CDC is also expected to conduct a site visit timely after the debenture purchase and that's to be submitted with the liquidation plans either the site visit findings can be put directly into the plan or the site visit report could be attached to the plan. The liquidation plan should provide complete information on all obligors, including their name, address, phone number, and most importantly, an accurate Social Security or tax ID number. And this is for if the SBA is going to pursue administrative wage garnishment or refer to Treasury for collections. You're required to give a detailed description of collateral along with the estimated recoverable value. The plan should provide the status of both hazard and life insurance. Are they still in force? If not, should the CDC try to do anything about it, should it be addressed? And finally and most importantly, the liquidation plan and this is the final part of the plan should provide a recovery plan. That is what the CDC's recommendation is in terms of the best way to collect this loan to maximize recovery and a recommendation.

Steve Katz  14:38  
Okay, and what about amended liquidation plans in emergency situations? What advice you have for CDCs on those?

Hollis Carter  14:46  
Well with the 30-day deadline after purchase you get a plan into SBA of course in some cases, the situation may be fluid, things have changed. There are certainly cases where it does require some type of amendment. And those cases you should get submitted before taking any action or incurring any expense that deviates from the original plan approved by SBA. But sometimes there are emergency situations. Things can crop up where there's really no time to get prior approval from SBA. So in those situations, SBA does allow CDCs to respond to that emergency without SBA's written approval, provided the action is in SBA's best interest and a good faith effort was made to obtain approval. But if it's just not possible, CDC should go ahead and make a decision, particularly if it's going to result from some type of recovery, that this basically got a time limitation to it without getting SBA approval, you shouldn't miss that opportunity. But the SBA does require that a written plan amendment to the plan be submitted as soon as possible after taking that action.

Steve Katz  15:55  
And in terms of the SBA's requirements regarding appraisals and BPOs, what info can you share with the audience on that?

Hollis Carter  16:02  
Great question. First of all, SBA defines a liquidation appraisal as an expert's opinion as to the value of specific property prepared specifically for the CDC and SBA's use with regard to a particular loan. So as you can see in the definition there, it doesn't specifically state that a state licensed appraiser must conduct the appraisal of course and in many cases, those can cost as much as I'd say anywhere from $3,000 at minimum to $5,000 or more if it's a complicated piece of property. SBA requires an independent appraisal. In years past, a shared appraisal could be used, but several years ago, SBA changed the rules on that. An independent appraisal is required and the only way you can deviate from that is to ask SBA to consider an exception to policy to allow the CDC to share an appraisal with a third-party lender. SBA is pretty reasonable in those circumstances if it makes sense. But again, for pretty obvious reasons SBA wants an objective look at the collateral and without any influence by the third-party lender if possible. And again, there are cases where an exception could be made. SBA may accept a liquidation valuation from a reputable auction company like Hilco in lieu of formal appraisal, and that they routinely do that. I mean, basically, what the liquidation folks at SBA are looking for is an accurate or reasonable valuation of what that property would bring in a forced sale situation. So again, sometimes an auction company, their liquidation valuation can even be better priced in some cases. Now a situation where it's an obvious no-bid, in other words, the collateral position of SBA is pretty much underwater, maybe the loan we just funded or closed a year ago and there's clearly no equity. In those cases, SBA would accept even a standard BPO from a local real estate broker, basically to pay for the file just to support that there is no equity there for SBA. In those cases, SBA would prefer not to incur a $3,000 to $5,000 appraisal expense.

Steve Katz  18:17  
Sure makes sense. All right. Wow, great information. As I said earlier, really appreciate you spending this time with us. Let's wrap it up today with something that we haven't touched on though, and that is protected bid analysis. So I've got two questions for you there. The first is, what are the SBA's expectations of CDCs when it comes to preparing a protective bid analysis?

Hollis Carter  18:38  
Well, good question. Once the appraisal or BPO is received by SBA from the CDC, the CDC is expected and I mentioned this earlier, they're expected to prepare a protective bid analysis using SBA's format to determine the recoverable value of the loan collateral. And by recoverable value what SBA or how they define it is the net dollar amount that a prudent lender could expect to recover from the liquidation of the collateral. So basically, for terms that would be the net proceeds SBA would receive sale of the collateral after the first lien holder was paid, any taxes, etc. recoverable property taxes, and any care preservation and sale expenses that were incurred by the third-party lender if they're the ones that were selling it. So basically, SBA's format requires CDCs to take their market value to CDCs who are expected to reduce that by 25% to come up with a liquidation value. Of course, if you have a liquidation valuation provided by some type of auction company as Hilco you would go with that liquidation valuation and essentially deduct all the cost and senior liens to come up with that recoverable value. But liquidation value is the difference between it and recoverable values. Liquidation value is the likely gross price to collateral sale for a for sale situation.

Steve Katz  20:07  
Okay, and then to follow up on that and close this out, could you walk us through the various possible uses of a protective bid analysis?

Hollis Carter  20:17  
Sure, the obvious use is to determine as I said whether SBA should bid or not bid at a third-party lender foreclosure sale. So this would be a protective bid. It could also be used if SBA was actually initiating a foreclosure but in other words contemplating a credit bid. That's very rare. SBA would prefer to bid at a third-party lender sale, but they do occasionally run into situations where perhaps the first lien has been paid off, or it's been paid down to a very low level, and SBA would really be forced into their own foreclosure action. So that bid analysis is very critical there. Another really good use and common use of it is analyzing short sale proposals. And this would be another good topic for a future podcast. But protected bid analysis is basically just a collateral analysis and it could be used to support a short sale proposal from the borrower. And finally, it could be very helpful in analyzing a Chapter 11 bankruptcy plan, in other words, supporting the decision whether to accept or reject a borrower's proposed plan. And just finally, to wrap up on protective bid analysis, SBA normally will enter a protected bid at a senior lienholder foreclosure sale if the recoverable value is 10% or more of the liquidation value. So there's really got to be fairly significant equity available before SBA will risk paying off that senior lienholder at their foreclosure sale.

Steve Katz  21:55  
Yep. Got it. All right. Well, thank you so much Hollis for sharing that wealth of information today. I think there was probably something new in there for just about everybody listening even the most savvy of CDCs. So I hope you'll come back soon and visit with us on other aspects of the SBA and CDC relationship and related topics.

Hollis Carter  22:15  
I'd be happy to Steve. I've really enjoyed it. Thanks for having me on again. 

Steve Katz  22:18  
Yeah, it was our pleasure. And for those certified development professionals, those from the SBA, and others who joined us today if you'd like to learn more about best practices in 504 Loan liquidation process and their relevance in the current pandemic environment, Hollis has asked that you reach out first to James Keith here at Hilco Real Estate because he and his team work very closely with Hollis on these matters. So here you go, James email is jkeith@hilcoglobal.com that's jkeith@hilcoglobal.com. And with that said, we hope today's Hilco Global Smarter Perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. Until next time, for Hilco Global, I'm Steve Katz.