SBA Lending Matters Newsletter
A Word from Arne

Recently, I attended the NAGGL (National Association of Government Guaranteed Lenders) National Conference. This annual event is a great forum – not only for meeting with industry experts and sharing ideas, but also for spending some valuable time with Pam Smith, Director of the SBA Loan Guaranty Processing Center in Citrus Heights, CA. Pam gave an excellent presentation on SBA Application Screen Outs and Declines. A Screen Out occurs when an SBA application is accepted for underwriting, but is missing some inputs. That application must be pulled out of the processing queue and set aside until the reason for the Screen Out is resolved. Holtmeyer & Monson strives every day to submit fully documented, compliant SBA applications on behalf of our clients to avoid Screen Outs and approval delays. In the rare event that an H&M-produced application is missing information, the SBA will generally call us to briefly discuss any file deficiencies so that the application can proceed more quickly. This professional courtesy is a by-product of our long-standing relationships with all of the SBA Loan Specialists, and benefits everyone involved in the transaction – lenders, borrowers and the SBA as well.

Screen Out Reason #1: Lender Credit Memo
So, what are the most common reasons for a Screen Out? The centerpiece of all SBA applications is the lender credit memo. An SBA Loan Specialist in California does not have the advantage of knowing your borrower, and it becomes critical for lenders to "tell the story" of the loan request in the credit memo. Adequate detail embodied in the lender credit memo will allow the Loan Specialist to gain quick familiarity with the request, and move the application along without delay. During our SBA lender training sessions with H&M clients, we place heavy emphasis on the preparation of high-quality lender memos. The SBA requires that these memos exactly match the respective SBA applications. In order to satisfy that requirement, we must occasionally advise our lender clients that they need to provide additional content in the credit memo. Please understand that our intent is to enable faster processing by the SBA.

Avoiding a Decline
No one likes for an SBA application to be declined, especially after all of the hard work required to complete it. At Holtmeyer & Monson, we pride ourselves on not submitting any application that is either ineligible or deficient to the point of affecting a decline. The top two causes of declines are (1) ineligible use of proceeds and (2) unsatisfactory credit for either the borrowing entity or its principal. We have committed to the SBA that we will not submit any application for their consideration that does not merit an approval. It is our obligation to be good stewards of government resources. In the event that we must advise a client lender, or borrower, that a proposed SBA loan application will be declined for any reason, you can be sure that we have reviewed the application with an SBA Loan Specialist to reach consensus regarding the reason for the decline.

As a reminder, a reality of SBA lending is that a loan may default and a Guaranty Claim and/or Liquidation may become necessary. We have developed a very high level of expertise in this area and encourage readers to contact us immediately if this type of situation arises.

In fact, we invite you to call upon us with any SBA-related question or issue you may have. We’ll be glad to share our knowledge on the subject. As a qualified SBA Lender Service Provider, we serve as the out-of -house SBA loan department for many banks. There’s almost nothing SBA related that we haven’t run across in this capacity, which is one of the reasons we were named a Preferred Service Provider of the Independent Community Bankers of America.

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Featured Article

Push and Pull
Two-sided SBA market doubles your chance for success
by Jim Reber and Arne Monson

Rufus Thomas, the late R&B impresario whose hit list included “The Funky Chicken” and “Walking the Dog,” was not known to be a market maker of Small Business Administration (SBA) 7(a) loans. It’s ironic, then, that he was talking about the two-sided benefits of both lending and investing in these products when he released his 1970 hit “Push and Pull.”

Hundreds of community banks have learned that this strategy can satisfy several needs on their balance sheets and income statements. The loan department makes quality loans, which are usually 75 percent guaranteed by the federal government, in many cases to borrowers that are outside the community bank’s traditional lending grid. The investment portfolio manager buys zero percent risk-weighted assets that are true floating rate instruments backed by these loans, at yields that far exceed other money-market alternatives. As Rufus himself might have said, “Let’s boogie!”

Hit it
The 7(a) program has grown exponentially in the last four years as the economy has expanded and borrowers have improved their own balance sheets. In fiscal year 2017, the SBA estimates that there will be requests for $29 billion in guarantees, up from $17 billion in 2013.

The growth in the program has had no impact on the national debt. The 7(a) program is “zero subsidy,” meaning that the fees charged the borrowers cover the costs of administration. That is a major reason the government has gradually approved larger appropriations. Of course, supporting private enterprise has been a hallmark of community banking for generations.

SBA (7a) loans are almost all floating rate tied to the prime rate. Borrowers’ rates can range from 1.00 to 2.75 percent over prime, and loan terms will vary based on use of proceeds. Working capital credits can be seven- to ten-year terms, while real estate-backed loans can be as long as 25 years.

About half of these loans are sold into a lucrative secondary market. The lender/seller is required to retain servicing (with a 1.00 percent servicing fee), as well as the full unguaranteed portion. The sale of the loan is not visible to the small business owner since monthly payments continue to be made to the originating community bank.

Pick up the beat
The sale of the loans is really just a step in the procession. The reason a community bank is able to sell its guarantees at 10 percent premiums and higher is that there are ready buyers of the securities collateralized by these small business loans. A consortium of poolers buys the loans and aggregates them into groups of homogenous maturities, then issues Guaranteed Loan Pool Certificates (GLPCs) backed by the U. S. government.

GLPCs have some obvious and tangible benefits for community bank bond portfolios. As mentioned, they’re floating rate, so the risk metric known as “effective duration” is very short. These securities are fairly liquid and pledgeable. They have monthly principal and interest cash flow, which further helps manage interest rate risk. Finally, the yields for these have been near that of a three-year Treasury note, in spite of their (usually) quarterly reset window.

Big finish
Let’s walk our way through an example. Currently, 10-year prime plus 2.00 percent loans can be sold to a pooler at a price of about 108.50. You, the lender/seller, would keep the 25 percent unguaranteed portion, and you would retain 1.00 percent of the guaranteed balance as servicing income. (Longer loans and those with higher note rates will have higher prices.) The premium represents gain recognized immediately on sale date.

Once an aggregator has accumulated enough 10-year loans to issue a security, it will do so at a price of about 109.00. (SBA requires a pool to have at least four loans and a face of at least $1 million, although most securities have a multiple of both.) The investor assumes one major risk: that the loans behind the pool prepay sooner than expected. This is why it’s vitally important for the buyer to examine detailed loan listings made available by the pooler, which is effectively the DNA. Generally, these investments will produce a yield that is about 100 basis points (1.00 percent) above the effective fed funds rate.

Seeking participants
This article barely scratches the surface of this subject. It is significant, though, that the number and dollar amount of 7(a) loans being made, and the number of community banks that own GLPCs, have skyrocketed in the last decade. That is validation enough of the benefits seen by the thousands of participants in the push and pull of this two-way market.

Jim Reber is president and CEO of ICBA Securities, an institutional fixed income broker/dealer and can be reached at 800-422-6442 or [email protected].

Arne Monson is president and CEO of Holtmeyer and Monson, the ICBA’s endorsed lender service provider and can be reached at 800-340-7304 or [email protected].

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Regulatory Corner

Equity Injections: Don’t Jeopardize Loan Guarantees
SBA has very clear requirements regarding equity injections into authorized loan transactions. Owners’ equity MUST be injected before loan proceeds are advanced. We have seen transactions where the lender will allow borrowers to inject equity on a pro rata basis, or after loan proceeds are disbursed. This practice is clearly not a condition of the SBA Authorization, and may jeopardize the guaranty. As loan applications are authorized and closing preparations begin, special attention must be paid to the injection and verification of required equity. Owners’ equity should be segregated from loan proceeds, and should be identifiable as bank deposits, checks or as line items on loan closing statements. Please call us and rely on our expertise as you prepare for SBA loan closings.

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SBA Hot Topic
SBA guaranteed loans with maturities of 15 years or greater are subject to a prepayment penalty the first three years of the loan life, even if the loan guaranty is sold in the secondary market. If your portfolio contains an SBA loan that will be paying off – or has a principal pay down greater than 20% and the guaranty is sold in the secondary market – you must notify the investor holding the guaranty. We handle this notification for H&M clients.

 

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