Has this happened to you? Sometimes there’s a discrepancy between what a lender’s policies require and what SBA requires – or in this case, doesn’t require. This can leave the borrower in a bind, which isn’t good for anybody. Case in point: A call from Loan Officer Larry Lender. At JRB, we hear Larry’s dilemma a lot:

LARRY. Richard, our Loan Policy requires the principal to contribute 25% cash or in-kind to the project costs. We have a borrower who is meeting most of its cash injection with a margin loan on his personal brokerage account. He has no income outside the business. And he earns sufficient income to handle the debt service without increasing his Officer’s Salary. Here’s the problem: If the principal liquidates his brokerage account, he’ll have a taxable event and will have to take out even more cash to cover the increased income tax. What can we do about this?

ME. As you know, SBA doesn’t require a borrower contribution to project costs for 7(a) loans (except for biz-acq loans). So SBA can finance 100% of the costs. Here’s your issue: What does your SBA Policy require? And if you haven’t got one ( Tsk! Tsk!!) what does your Loan Policy require for similar-sized conventional loans?

That the principal has sufficient income to cover the debt service without increasing his officer’s salary is good. But that he would be faced with a 25% taxable event is an effect of your institution’s policy, not any SBA policy. It is entirely up to your institution to choose how much cash injection to require. We recommend including such items in your Loan Policy.

Here’s the stickler: Lenders have a general aversion to making a Loan Policy too detailed. Regulators expect policy to be followed. If you have 1,001 items in your Loan Policy, the regulators will expect each one to be followed and if not, that you track each exception. Too many exceptions call into question the effectiveness of your entire Loan Policy.

Our Recommendation …“Build in” to your Loan Policy a sentence covering all SBA loans. So if your Loan Policy generally requires a 25% of project costs contribution from the principal, a separate sentence in your Loan Policy will say, “Loans guaranteed by SBA do not require a contribution from the principal.” Since SBA has no required contribution, and SBA loans are now part of the policy and not an exception, your institution has flexibility without jeopardizing its loan portfolio.

Then when the regulator asks, “Why didn’t you require a contribution from the principal?” you’ll point to your policy and say, “As stated in our Loan Policy, SBA-guaranteed loans don’t require a contribution from the principal.” The regulator will say  “Oh, thank you very much, loan officer. Very kind of you to point that out,” to which you can respond “Not at all, regulator. Happy to assist.”

Now, what a nice conversation to have with a regulator!

Richard Jeffrey, Senior Associate
Chief Underwriter
richard@jrbrunoassoc.com
www.jrbrunoassoc.com