A loan that looked good goes sour. What triggers early default? Several factors can contribute:
- The borrower fails to make a scheduled loan payment.
- A scheduled loan payment is made with proceeds from the sale of collateral rather than from business operations.
- There is deferment of more than three consecutive scheduled full payments; or
- Any other event of default that required the loan to be classified in liquidation (e.g., bankruptcy, business closure).
Here’s the timeline. It’s a mouthful: If any of these events occurs within 18 months of the loan’s initial disbursement, or within 18 months of final disbursement (given that the final disbursement occurred more than 6 months after the initial disbursement) and the borrower fails to cure the default and make the scheduled loan payments for 12 months after the initial 18 months, your loan is in early default. (SOP 50 57 2, Chapter 2. Definitions, 13., pg. 14)
Did you make a ‘bad’ loan? Early default happens more often than you’d think, and it doesn’t mean you made a bad loan. Life happens. A loan can go into early default for any number of reasons…death of a principal, a natural disaster, the borrower over extends its services, or poor management. These instances cannot be predicted but they can be weathered.
Can the loan be saved? Maybe. Not every early default results in repurchase of the guaranty. You might be able to offer assistance to the borrower, allowing them to recover, continue in business, and pay the loan in full as agreed. Yet more often, early defaults lead to repurchase. SBA’s repurchase package for early default requires information from the loan’s origination, including but not limited to the credit memo, the business financials, tax returns, IRS verifications, proof of injection and documentation of the injection source(s).
Prepare. Prepare. Prepare. Document. Document. Document. The Early Default Tab 7 of the Repurchase Request is where we see lenders having issues with repair or denial. What to do? Plan ahead. At origination, your processes for every loan should assume they will be in early default. And it all comes back to our favorite word: DOCUMENT. Make sure you document your file with all the required backup for eligibility, closing and disbursement. If you do that, you’ll be ready if the file should ever be an early default.
Early defaults can be tricky. At JRB, servicing and liquidation is one of our specialties. We’re here to help guide you through the process. Contact JRB!