U.S. Small Business Administration (SBA) guarantees are the cornerstone of SBA loan programs. This credit enhancement certifies to lenders that if a borrower defaults on an SBA-approved loan, the SBA will purchase the guaranteed portion of the loan. SBA guarantees typically cover 50% to 85% of the value of each loan. This substantially reduces the risk that lenders assume when working with startup or expanding businesses, especially in industries that may be challenging to finance. Likewise, the SBA guarantee is catered to small business clients who have difficulty obtaining conventional bank financing for various reasons.
The SBA’s guarantee is conditional (as opposed to unconditional). From origination to liquidation, lenders must adhere to specific rules for and record keeping of their files in order to retain the SBA’s guarantee. At Prudent Lenders, we work closely with our partners to alleviate any and all lending pain points, whether observing protocols or maintaining SBA guarantees. Nonetheless, it’s helpful for our clients to overview the requirements as well.
Here are three tips to ensure that your institution’s SBA guarantees are protected:
Track equity: See, source, spend
The SBA requires that lenders provide evidence of a borrower’s equity injection (i.e. contribution to a project) and ensure the funds aren’t fraudulent or borrowed. The phrase “see it, source it, spend it” is an easy way for lenders to remember the required process.
- See the equity: Follow the funds into the borrower’s business account. If monies are being spent prior to loan application or loan closing, obtain copies of invoices and receipts for services, products, equipment and/or other uses. Equity should be seasoned; and ideally, funds should stay in the business depository account for a minimum of two months prior to injection into the project. The borrower must supply relevant deposit statements attesting to such a timeline.
- Source the equity: For unseasoned funds, follow the money into the borrower’s account and track how they are derived. At this point, the source of equity may be multi-layered (i.e. general operating funds, personal funds, affiliate corporate funds, gift funds, etc.). How the money is derived will dictate necessary action. For instance, gift funds require a gift letter and source documents; whereas personal or affiliate corporate monies may require a subordination depending on how these funds are injected into the project.
- Spend it: How are the funds used? Lenders must obtain and keep copies of checks along with accompanying invoices detailing how funds are spent.
The SBA’s authorization and SOP requires lenders to obtain specific collateral. If equipment is taken as collateral, the SBA requires a list of said equipment, including serial numbers for items more than $5,000.00 in value. The list should be signed and dated by the borrower for the loan file. In the event no serial numbers are available, the list should state that. In some cases, third-party valuations may be required such as appraisals or business valuations.
What do you do when your borrower is faltering on their payments? In these instances, it’s best to be proactive. Getting ahead of the challenge may mean the difference between a restructured loan versus a liquidated loan. Still, to temper moments of human crisis, you should understand what is required by the SBA for a defaulted borrower.
If a borrower is behind on loan payments by 60 days or more, the SBA calls for a representative from the lending institution to conduct a site visit in a timely manner. Likewise, if something may have a substantial negative impact on the borrower or the business—such as a natural disaster—the lender is required to make a site visit within 15 days of the event.
Site visits help lenders assess a business’s physical circumstances. Being onsite yields firsthand knowledge as to a borrower’s short-term needs and to potential long-term solutions.
Steps for Protecting Your SBA Guarantees During the Special Assets Workout Process
As a small business lender, one of the more challenging scenarios you may face occurs when a borrower is in default on a U.S. Small Business Administration (SBA) loan. In these cases, the loan hasn’t been paid for 90 days or more, which triggers an SBA default and the special assets workout process.
Although an SBA default is a difficult situation for lenders and borrowers alike, it’s important to know that the vast majority of SBA loans are repaid as agreed. When an SBA default does happen, though, there are clear steps to take so that lenders can protect their loan guarantees during the workout process.
What is an SBA loan workout?
A special assets workout, or loan workout, is the debt collection and negotiation process that takes place with an SBA default. SBA loan workouts are conducted to determine how the defaulted debt will be settled, either through modifications or intensive servicing, as well as the final plan that a lender and borrower agree upon. (SBA SOP 50 57 2). As the SBA states, “a workout agreement restructures the material terms and conditions of the debtor’s delinquent loan in order to:
- Avoid the need for actions such as foreclosure or bankruptcy
- Enable the debtor to cure defaults and improve repayment ability; and
- To enable the creditor to maximize recovery on the loan.
It’s important to note that loan modifications are only considered when the borrower is experiencing short-term problems. Examples include construction in front of the business (which limits access to the business and causes cash flow issues), a hacked bank account, etc. Oftentimes, SBA defaults are due to longer-term business issues such as business closures, bankruptcy filings, landlord eviction of business premises, or tax foreclosure of commercial properties. In either case, our team is here to take the proper steps to ensure your SBA guarantee is protected.
More about the workout process
In this Q&A, we asked Morgan Petzold, Assistant Vice President, Special Assets, about the workout process, including what to expect and the necessary steps lenders must to take to protect their guarantee.
Q: What triggers the special assets workout process?
A: Unlike loan delinquency, in which a borrower is typically late on a payment but does pay, the workout process is triggered when a borrower defaults on an SBA loan by missing several payments, usually over 90-120 days. The cause may vary – sometimes, it’s operational issues and other times, it’s the result of unfortunate circumstances such as a long-term illness. In any case, the outcome is that the business isn’t paying back the loan as agreed.
For lenders and borrowers alike, there are SBA default consequences, but we can help make the process easier and more efficient for lending partners to help minimize any negative impacts.
Q: What’s the first step that a lender needs to take in the workout process?
A: The first step is to determine the loan’s status and, specifically, how far it’s past due and whether it was sold on the secondary market.
Prudent Lenders makes this easy with a ‘Past Due Questionnaire.’ It can be filled out and submitted online. Once we receive it, our team will use this to assess the loan’s status and determine the best ways for lenders to move forward.
Q: Once the loan’s status is determined, what’s next?
A: Once we know the loan’s status, we’ll talk through next steps with the lender. They typically include actions that are required by the SBA, like conducting site inspections to establish the status of all collateral.
We’ll also connect with our loan-modifications department, who will help determine whether a loan is eligible for payment deferral or modifications. If so, then we may be able to work out a solution that helps the borrower get back on track with payments. When that happens, Prudent Lenders will closely monitor the loan to ensure compliance with SBA operating procedures.
Q: What if modifications or deferrals aren’t an option?
A: If it looks like a loan can’t be saved through modifications or deferrals, or if it’s been sold on the secondary market, we’ll review other options, such as liquidation and, if needed, litigation, with our lender.
Q: Are SBA loan defaults common?
A: It’s important to know that SBA loan defaults are rare. And, just as important, know that when they do happen, we’re here to support you. We have industry-leading experience and we’ll ensure that the workout process is handled correctly and efficiently. And we’ll be with you through every step to find the best solution for you.
Prudent Lenders maintains SBA guarantees
In addition to the action items mentioned above, it’s imperative that all loans are closed in adherence with SBA authorization and serviced wisely. Prudent Lenders has also created a helpful summary of the SBA guarantee fees charged in conjunction with a 7(a) or Community Advantage loan. With our partnership, you can minimize the time and resources spent on learning and applying SBA rules – we’re here to do the heavy-lifting.
SBA Guarantee Fees
The following outlines the fees charged by SBA in conjunction with a 7(a) Community Advantage loan.
- A Lender must pay a fee to SBA for each loan guaranteed under the 7(a) program. This fee is known as the “SBA Guaranty Fee.” The total loan amount determines the percentage that is used to calculate this fee. The guaranty fee is based on the guaranteed portion of the loan and not the total loan amount.
- The Guaranty Fee may be passed on to the borrower. In most cases this is rolled up into the loan and financed by the borrower.
- Payment of the Guaranty Fee by Lender to SBA must be made within 90 days of the date of loan approval.
- If more than one loan is approved to the same Applicant, including loans to its affiliates, within 90 days of each other, the loans are considered as one for the purpose of determining the guarantee fee.
Among our full suite of offerings is unmatched assistance regarding SBA-guarantee products. We enable your institution to stay compliant so your SBA-guarantees are there when you need them! Get in touch today if you have questions regarding the closing or servicing of one of your loans. Not a partner yet? Contact us to learn how Prudent Lenders will expertly protect your SBA guarantees by skillfully closing and servicing your loans.