SBA Lending Matters Newsletter
A Word from Arne

As I travel around the country speaking to bank clients and borrowers, two common themes are prevalent: When should a bank and/or borrower consider using an SBA loan program, and what are the key differences between a conventional loan and an SBA loan? Three scenarios lend themselves to using a credit facility guaranteed by the SBA. Please consider the following strategic options when working with your small business borrowers.

1.  Startup Ventures - These business entities have inherently higher risk levels, and their value is based on projected operations without any history. Their credit applications are heavily weighted on the experience and capital adequacy of the owners. In the case of franchisees, the risk level is somewhat mitigated, as the franchise has an industry track record and a support system to promote the success of its individual franchised operations.

2.  Business Acquisitions – Any time an existing business entity is being sold and is in need of bank financing, SBA lending should be considered. Sales transactions often involve goodwill considerations or intangible assets, and these factors make securing conventional financing very difficult. However, the SBA does allow for the recognition of goodwill or “enterprise value” determined by an independent business valuation. This valuation can be reflected on a pro forma balance sheet.

3.  Debt Refinancing – I continually see borrowers who have established their financing structures very poorly. For example, they might have financed long-term business needs with short-term or revolving credit, putting undue pressure on their cash flows. I firmly subscribe to the notion that NOTHING is more important to a successful small business operation than cash flow. By refinancing existing debt using SBA guaranteed loans with extended terms, lenders can offer borrowers much-needed credit at terms that would be unavailable otherwise. SBA loans of less than 15 years have no prepayment penalties. If at some point a borrower has excess cash, s/he can always make additional principal reductions.

As always, please call upon Holtmeyer& Monson with any SBA-related question or issue you may encounter. We welcome the opportunity to serve you in any way. As a qualified Lender Service Provider, we can operate as your out-of-house SBA loan department and we would be happy to fill this need for your institution.

Featured Article

Best Practices: Protecting the SBA Guaranty
By: Ethan W. Smith, Esq.

The life-cycle of an SBA loan can be divided into four main sections: 1) Underwriting/Origination; 2) Documentation/Closing; 3) Servicing; and 4) Liquidation. SBA lenders often find themselves focusing on one or two of these areas in their efforts to preserve and protect the SBA guaranty. However, SBA lenders should be mindful that the guaranty can be jeopardized in any one of the four stages of a loan.

In the Underwriting/Origination phase of an SBA loan, mistakes can be made which imperil the guaranty regardless of subsequent actions taken by the lender. For instance, determinations regarding loan structure and eligibility, if incorrectly made, will often result in a recommendation for denial of the guaranty by the SBA National Guaranty Purchase Center ("NGPC"). Issues such as franchise eligibility, credit elsewhere, size standards and loan purpose must be correctly made or the guaranty will not be honored. Additionally, lenders' credit decisions must be sound and well documented - early default loans will have their credit decisions reviewed by the agency. Although the SBA will not "second-guess" credit, the burden is on the lender to ensure that it has sufficiently documented its credit as a prudent lender.

The Documentation/Closing phase of an SBA loan is an area that results in many repairs and denials of the SBA guaranty. Often, lenders will miss items in their due diligence such as intervening liens, missing tax transcripts, insufficient payoff letters, etc., that can give rise to repairs or denials of the SBA guaranty. SBA reports that the most frequent reason for a repair of the SBA guaranty is the failure to obtain the correct lien position on collateral as set forth in the Loan Authorization. Lenders' failure to perform the correct searches and/or to resolve issues shown by the searches properly and thoroughly is often to blame. Additionally, failure to obtain a commitment from a creditor to release the lien being paid off also creates problems for lenders. Finally, lenders sometimes fail to properly document and/or perfect their liens which can also risk the guaranty.

In the Servicing phase of the loan, lenders can endanger the guaranty by making servicing decisions that are imprudent or by failing to seek the approval of the agency when required. The SBA has made this process easier for lenders by issuing the Servicing and Liquidation Actions 7(a) Lender Matrix, which sets forth when SBA approval is required. However, it is important to remember that even if an action is delegated to the lender as a unilateral action, the lender must still document its file as to the reasoning and justification for each significant servicing action that it takes. Failure to do so can leave the SBA no choice but to recommend a repair if it cannot determine why the lender did what it did, and why it made sense.

Finally, in the liquidation phase of the loan, lenders often make simple mistakes that have big consequences for the guaranty. For instance, lenders often fail to perform site visits within the mandated 60 days following a payment default. Although seemingly innocuous, the failure to perform the site visit in a timely manner shifts the burden to the lender to prove to the SBA that the failure to timely visit the site did not contribute to any loss. This can be a difficult, if not impossible, argument to make, especially if collateral is missing.

SBA lenders need to be vigilant about guaranty protection throughout the entire life of an SBA loan. The four phases of an SBA loan, these "four pillars" of guaranty protection, are like the legs of a table - the loss of any one will likely make the "table" collapse and will expose the guaranty to repairs and denials.

For more information on preserving the SBA guaranty throughout all phases of an SBA loan, contact Ethan at [email protected] or (215) 542-7070.

Regulatory Corner

SBA Clarifies Eligible Uses of Proceeds for EPC/OC Loan Structure
Recently, the SBA made a clarifying amendment concerning the eligible use of loan proceeds for what is commonly known as the EPC/OC loan structure. The structure involves an EPC (real estate owning entity) that is leasing property to an OC (operating company entity) for the OC to operate its business. This is a common practice for tax planning and liability purposes; the same principals own the commercial real estate and the operating business that is housed there. Effective May 17th, SBA allows an EPC and an OC to make a 7(a) application as Co-Borrowers if the loan proceeds are to be used for multiple purposes. An example of this rule would be an Applicant that needs to refinance commercial real estate owned by an EPC, as well as to purchase equipment and provide working capital for an OC. This rule clarification eliminates the need for the small business to obtain two separate loans to meet its multi-use financing needs.

Please call your Holtmeyer & Monson representative for additional details about this issue.

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The SBA has revised its onsite risk-based review process to include an expanded 7(a) Risk-Based Lender Review File Checklist. We use a version of this checklist in our application preparation process, and can make our tool available to Holtmeyer & Monson clients upon request. We will also perform file reviews at a lender’s request. For details, please contact Arne Monson.


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