Don’t Take Government Guarantees for Granted: How to avoid jeopardizing your SBA loan guarantees

If your bank participates in U.S. Small Business Administration (SBA) lending programs, it must comply with all SBA requirements and standards to ensure that the government will honor its loan guarantees.

SBA lending offers significant benefits for banks. Under the 7(a) program, for example, the SBA guarantees up to 75% of loans to eligible small businesses (85% for loans of $150,000 or less), with a maximum loan amount of $5 million. These loans allow banks to expand customer base, reduce risk, boost lending capacity (the guaranteed portion of these loans doesn’t count toward a bank’s legal lending limit), and improve liquidity (the guaranteed portion can be sold on the secondary market).

Preserve the guarantee

The key to the benefits of SBA lending is the government’s guarantee. If a borrower defaults, the SBA will scrutinize the loan file to ensure that the lender has complied with SBA requirements, as well as SBA loan authorization and prudent lending practices. If the lender doesn’t meet these standards, the SBA may reduce the amount of the guarantee (known as a “repair”) or, in more extreme cases, deny the guarantee altogether.

Here are common reasons for a repair or denial:

Lien or collateral issues. Examples include failure to obtain the required lien position, failure to properly perfect a security interest or failure to fully collateralize the loan at origination when additional collateral was available (usually a repair).

Unauthorized use of proceeds. This involves disbursing proceeds for purposes inconsistent with the loan authorization (denial or repair, depending on the circumstances).

Liquidation deficiencies. These include failure to conduct a site visit, improper safeguarding or disposition of collateral, and misapplication of recoveries to the lender’s loan (usually a repair, but could be a denial if the harm is the full value of the outstanding balance).

Undocumented servicing actions. This includes failing to renew liens when required, releasing or subordinating collateral without a documented business justification, and allowing hazard insurance to lapse on collateral that’s later destroyed (usually a repair).

Early defaults. Typically, early defaults occur within 18 months if there are lender omissions, such as missing or unsupported verification of a required equity injection or missing or unsupported documentation of verification of borrower financial information with the IRS (possible denial if the SBA determines these omissions are the reason for the borrower’s business failure).

SBA loan eligibility issues. These may involve an ineligible franchise, ineligible loan purpose or ineligible loan recipient — for example, a loan to an associate of the lender (usually a denial).

If the SBA denies or reduces a loan guarantee, your bank will have an opportunity to present its case to honor the guarantee. But this time-consuming process will require convincing evidence showing that the bank’s actions were prudent and consistent with SBA requirements and the loan authorization.

Review your program

To preserve the benefits of SBA loan guarantees, review your bank’s SBA lending program. Make sure you have policies, procedures, checklists, controls and properly trained staff in place to ensure that your bank complies with SBA requirements. And be vigilant in monitoring SBA loans to avoid deficiencies that can jeopardize loan guarantees.

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