Sometimes I think taking an SBA loan from origination to funding is like running in a track meet. Lots of hurdles and stumbling blocks along the way to crossing the finish line — and taking a victory lap, holding our guaranty high. As in a race, successful SBA lending begins with a fast start: determining eligibility early on and properly documenting at every turn, from application through loan closing and disbursement.
Yes. Eligibility issues can bog you down. Full disclosure, transparency and attention to detail are the keys to avoiding denial of your guaranty. Most importantly, be aware of and abide by the eligibility requirements in 5OP 10 5 (K). (Subpart B, Chapter II)
Clearing the hurdles. Eligibility issues that can lead to denial of your guaranty. Some issues we’ve come across in working with clients across the country:
Affiliate issues aren’t fun and easy, but they’re important to keeping your guaranty. Determining who is an affiliate, how they impact loan structure, size standard, and global cash flow, and the need to require additional guarantors/collateral is critical to SBA eligibility.
Use of Proceeds. Funds must be used for eligible business purposes. As a lender you need to document your files with the Promissory Note and the original use of proceeds for loans being refinanced with an SBA loan. Proceeds for business acquisitions must have documentation supporting business value, arms-length transactions and debt service. Memos to file or 327 Actions for the reallocation of use of proceeds are imperative – items we’ve often found missing in files we’ve reviewed.
Injection Verification. SBA requires lenders to provide proof that injected funds were received and applied according to the total project breakdown – and also to source the funds injected. Imperative: Get 2-3 months bank statements to verify funds injected. It’s all about “checks and balances.” Let’s say John Smith injects $200,000 into his purchase of CRE for his business, Smith Electronics. His PFS shows that he has those funds available in cash. His bank statements should support that he has $200,000 available to inject. If months 1 and 2 reflect $100,000 available and month 3 increases that to $200,000, you need to source that $100,000: His IRA? Sale of property? New loan? Gifted funds? We’re looking to do a future eBulletin on injection. But for now, track and document that source!
IRS Verification. In early defaulted loans (those that default in that 18-months window) a lack of IRS Verification of borrower and seller tax returns can lead to a denial of your guaranty.
Appraisals/Business Valuations for loans where real estate or businesses are being acquired are essential and required to protect your guaranty. Be sure that the proper level of valuation and the person performing the valuation meet the SBA requirements in SOP 50 10 5 (K), Subpart B, Chapter 4, IV., pgs. 201-205.
Repairs or a reduction of your guaranty can happen when:
- Failure to obtain the proper lien position on collateral which leads to the loss of recovery in liquidation. SBA will reduce your guaranty by the dollar value given to the collateral lost.
- If additional collateral was available and required to be taken, but wasn’t, SBA will reduce your guaranty by the dollar value given to the missed collateral.
- Failure to reallocate funds properly or allocate funds partially for an ineligible use of proceeds, the repair would equal the reallocation or ineligible funds. Let’s say your loan is for $110,000 of equipment and the borrower purchases only $40,000 and wants to reallocate those funds to working capital. You need to be sure you perform the proper analysis of the request … is $70,000 in additional capital needed or can the loan be reduced? Prepare a memo to file and if required, obtain SBA approval of the reallocation.
- Servicing actions that occur without proper SBA approval such as release of a guarantor.
- Failure to insure the collateral when there is a lapse in Borrower/Guarantor coverage and the collateral is lost/stolen or destroyed. This would also apply to a failure to maintain life insurance on the owner and the owner dies.
- Failure to apply recovery from liquidations correctly. We see this when a lender has a non-SBA companion loan but applies collateral to the non-SBA loan or shares pro-rata with the SBA loan when the SBA loan has seniority position. When you have a regular commercial loan to a borrower in addition to the SBA loan, and they share collateral, it’s important to apply any recovery received to the loan in senior position. Or if this is truly a shared position, then pro-rata. If your conventional commercial loan isn’t in senior position, paying it off first is an error that will impact your guaranty.
At JRB, we’ve been running the SBA race for 25 years. We can help you lap the field to victory. Contact JRB.
Special JRB Invitation! SBA Expert Jan Garlitz will conduct all-inclusive 3-Day in-person 504 Loan Training classes Sept. 23-25, 2019. You’ll learn from the best and be fully equipped to close SBA 504 loans. We’re excited to host this event!! Click here to learn more and register