Financial institutions that participate in Small Business Administration (SBA) lending know that the program provides added opportunities to expand their lending activity, generate additional revenue and potentially meet their Community Reinvestment Act (CRA) objectives. It’s exciting when an SBA loan gets to the finish line, closes and funds.
The SBA’s guarantee covering 75% or more of the loan is a big benefit to banks; it significantly reduces the risk and the guaranteed portion doesn’t count against the bank’s legal lending limit. Banks that sell the guaranteed portion of the loan into the secondary market can book the gain on sale as additional income immediately.
But it’s important for bankers to keep in mind that just because the loan secured an SBA guarantee at the time of origination doesn’t mean that it will be there if you need it — that is, if the borrower defaults on the loan for any unfortunate reason. If your institution requests the SBA to honor the guarantee, SBA will review the loan file to make sure the bank properly closed, documented, funded and serviced the loan according to the bank’s approved credit memo and the SBA Loan Authorization. They will review it with a higher level of scrutiny when it is considered an early default, or a loan that defaults within the first 18 months. If the loan file is not documented properly or the bank failed to meet any of the requirements, SBA will issues a repair — or worse, a full denial of the guarantee. For that reason, it is important that your bank has proper procedures in place which include a pre- and post-closing review process to ensure lenders don’t miss or overlook items.
As a lender service provider that provides loan file review services for SBA lenders nationwide, I can tell you that lenders are often surprised about the types of documentation deficiencies that we uncover during a review. The deficiencies typically come from a lack of proper procedures and checklists, lack of training, misinterpretation of the program rules and requirements, or just lacking the appropriate staff to properly conduct pre- and post-closing reviews and monitor important post-close items.
The top five material deficiencies leading to a repair or denial of SBA guarantees are:
- Lien and collateral deficiencies.
- Ineligible or unauthorized use of proceeds.
- Debt refinance eligibility or documentation deficiencies related to debt refinance.
- Not properly documenting the equity injection or source of equity funds.
- Not properly documenting disbursement of loan proceeds.
The SBA will also review the loan file for any post-close servicing actions that may have occurred during the life of the loan. These include loan payment deferments, changes to the maturity date, assumption requests, release or exchange of collateral, changes to the ownership structure or release of a guarantor. The SBA expects your institution follow prudent lending standards and SBA program requirements when negotiating a feasible workout structure, considering an offer in compromise or liquidating an SBA loan.
It is imperative for institutions to properly document all service actions, conduct site visits as required and submit a written liquidation plan when appropriate. This is where lenders often seem to fall short and are taken off guard when the SBA comes back with a repair or denial of the SBA guarantee because of such documentation deficiencies.
The key takeaway is that it’s always important, but especially more so now in this economic environment, to properly monitor your institution’s existing SBA portfolio. Make sure your bank has properly trained staff, well thought-out procedures and checklists for all functions and proper staffing in each area. Engaging a third party that has a high level of SBA experience to occasionally review your bank’s files and provide feedback on how well processes are working is a good practice. A highly skilled SBA reviewer can help banks identify potential deficiencies and provide recommendations for best practices that will help them keep those loan guarantees.