About this PowerPoint... These slides are provided as a reference for conference attendees While the conference breakout session covers the same topics, the live presentation is a lender-to-lender discussion and will not follow these slides 2 Why this Topic? With more and more delegated authority, lenders are more at risk for having their actions second-guessed at time of purchase Especially if loan is an early default (generally defined as default within 18 months of 1st disbursement) So, it is important to know what SBA expects to see in your loan report regarding some of the most important / controversial topics 3 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 1
Session Objectives What do you need to include in a credit memo for loans of $350,000 AND less? Discussion of Credit Elsewhere Eligibility Underwriting Equity Requirements Collateral Loan Proceeds-Specific Requirements 4 Issues that MUST be Addressed in Credit Memo 5 Is Credit Available Elsewhere? Threshold Eligibility Criterion No financial assistance shall be extended pursuant to this subsection if the applicant can obtain credit elsewhere [Small Business Act, Sec. 7(a)(1)(A)] The Small Business Applicant Must Demonstrate a Need for a Guaranty on the Loan [SOP 5(G), page 84] 6 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 2
Documenting Need for Guaranty Lender must document in the loan file the factors that prevent the financing from being accomplished without SBA support Rationale must be specific to the individual loan a generic statement is NOT enough Elimination of Personal Resources Test likely will mean greater scrutiny of Credit Elsewhere rationale 7 Is the Applicant Small? Size based on one of two standards... Traditional SBA size standards www.sba.gov 13 CFR Part 121 OR Alternative size standard For both based on size of applicant AND any affiliates NAGGL TIP: Both tests remain important since applicant may be small under one, but not the other 5(G), pages 75-77 8 If there is a Franchise Agreement Is it Eligible? Main concern is possibility of affiliation via Common ownership Common management Excessive restrictions on sale/transfer of franchise interest Control by franchisor directly or through h an affiliated entity or agent such that franchisee does not have independent right to profit from efforts or bear loss commensurate with ownership Eligibility determinations If processed in LGPC review and determination by SBA If PLP, SBA Express, etc. review and determination by lender 5(G), pages 77-84 9 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 3
Is the Business Industry Eligible? SBA regulations and SOP list those industries that are ineligible for 7(a) loans Generally to be eligible the applicant must Be an actively operating business, i.e., one that provides a product or a service, not, e.g., areal estate holding company Exception for EPC/OC structures t Not be engaged in a speculative industry, e.g., gambling, oilwildcatting, some types of financial services, etc. Be a federally legal business, e.g., a marijuana dispensary is NOT eligible Be open to the public in a non-discriminatory way Not promote a specific religion Not provide sexual material 10 Credit Standards for 7(a) Small Loans 11 General Guidance Re: Credit Analyses (for loans of all sizes) Lender must analyze in commercially reasonable manner, consistent with prudent lending standards Applicant s cash flow is primary source of repayment not liquidation of collateral Application must be declined if cash flow inadequate to provide reasonable assurance of timely repayment, regardless of collateral available or outside sources of cash 5(G), pages 154-160 NAGGL Caution: SBA, particularly OIG, now scrutinizing credit analysis on early-default loans processed under lender s delegated authority 12 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 4
Three Credit Policies 1. 7(a) Small Loans (formerly SLA ) loans of $350,000 or less meeting SBA s minimum credit score 2. Loans over $350,000 AND Small Loans NOT meeting minimum credit score AND ALL CAPLines loans 3. Loans processed using SBA Express or Export Express [But, remember that basic eligibility requirements are the same for all 7(a) loans] 5(G), pages 154-158 13 Credit Analysis Requirements 7(a) Small Loans 14 Use of SBA Credit Score for Loans $350,000 With some exclusions a credit score acceptable to SBA substitutes for several elements previously required for traditional credit analysis Exceptions CAPLines SBA Express Export Express 15 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 5
SBA s Credit Scoring SBA s proprietary credit score (FICO/D&B) calculated based on a combination of: Consumer and business credit bureau data Borrower financials AND Application data Minimum score based on lower end of risk profile current SBA portfolio Current acceptable score = 140 SBA may adjust up or down Will post on its website the minimum credit score for small loan applications (www.sba.gov/for-lenders) 16 Screening for Credit Score Screening for Credit Score Required Pre-screening no longer mandatory may be done as part of application Although SOP not clear, SBA has confirmed that if loan pre-screened for score, it will be re-scored when submitted to SBA and must meet minimum score at that time Reminder: DUNs # not mandatory, but SBA prefers 5(G), page 154 17 SBA Credit Scoring for Small Loans Credit score acceptable to SBA satisfies requirements for: Credit history of the applicant (and any OC), its associates, and guarantors, including historical performance (character and reputation determined by SBA Form 1919) Strength of the business Past earnings, projected cash flow, and future prospects Applicant s ability to repay the loan with business earnings Other credit analysis elements still required... 18 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 6
Additional Credit Analysis Requirements Lender s credit memorandum will also be used to demonstrate reasonable assurance of repayment Credit memo must address History of the business Bi Brief fdescription of fthe management tteam Owner/guarantor analysis including obtaining personal financial statements, consistent with lender s similarly-sized non-sba guaranteed commercial loans Confirmation of lender s collection of business tax returns and verification and reconciliation of the applicant s financial data against income tax data prior to submitting the application to SBA... 19 Additional Credit Analysis Requirements (cont) Requirements for lender s credit memorandum - Lender must determine if equity and pro forma debt-to-worth are acceptable based on its policies and procedures for its similarly-sized, non-sba guaranteed commercial loans -If lender requires an equity injection and, for its similarlysized, non-sba guaranteed commercial loans verifies the equity injection, it MUST do so for SBA loans List of collateral and its estimated value, if secured Effect any affiliates may have on the ultimate repayment ability of the applicant 20 What if Loan Meets SBA s Minimum Score, but There are Credit Blips? Ex: loan scores 173, but two large judgments against business owner Part of the required credit analysis is conducting an Owner/guarantor analysis So, SBA would expect you to address guarantor s credit weaknesses When in doubt as to approval, you can always submit to SBA (LGPC) 21 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 7
7(a) Small Loans NOT Meeting Minimum Credit Score May be processed either through LGPC or via PLP BUT must meet requirements for loans > $350,000 Or, if lender is an approved SBA Express lender, may be processed as an Express loan subject to 50% guaranty 5(G), pages 154, 195 22 Equity Requirements e e 23 Equity Requirements Loans of $350,000 and less Lender must determine if equity and pro forma debt-toworth are acceptable based on its policies on similarly- sized non-sba loans If equity injection required, must be verified if lender s policy would require verification on conventional loans 5(G), page 155 24 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 8
Collateral Requirements for 7(a) Small Loans 25 Loans $25,000 Loans $25,000 or less Lender not required to take ANY collateral Yes, really not even assets purchased with loan proceeds BUT, personal guaranties still required 26 Loans > $25,000 and $350,000 LOAN DOES NOT HAVE TO BE FULLY SECURED! Lender must follow its conventional loan collateral policies for loans of similar size BUT In addition to core requirements, at a minimum lender must obtain Lien on all of applicant s fixed assets [defined to include business R/E] BUT while not clear in SOP, per SBA only required to take collateral up to the loan amount AND may take a lien on trading assets (using 10% of book value) if it does so for its conventional loans 27 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 9
Personal Guaranties And, don t forget that for loans of ALL sizes SBA requires full, unlimited personal guaranties required from all owners of 20% or more, including other entities 5(G), pages 163-164 28 Special Credit Memo Requirements Based on Purpose of Loan 29 Debt Refinancing Refinancing allowed only if Original loan purpose would have been eligible for SBA guaranty Loan was made to business and/or ALL loan proceeds used for business purposes Current creditor is not in a position to sustain a loss on the loan With some exceptions, refinancing will provide at least a 10% improvement in borrower s cash flow based on a reduction from current payments 5(G), pages 109-114 30 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 10
Business Debts That May Be Refinanced SOP provides a list of the loans that may be eligible for refinancing including Loans with demand note or balloon payment Loans with excessively high interest rates Credit card debt used for business-related purposes p Debt that is over-collateralized LOCs original lender is unwilling to renew/restructure Debt with inappropriate maturity Certain debt used to finance a change of ownership Other debt that lender believes no longer meets the needs of the applicant BUT standard 7(a) processing required 5(G), page 109 31 Credit Memo Must Address... Why was debt incurred? Has over-obligated or imprudent borrower necessitated a major restructuring of the debt? Is debt currently on reasonable terms? How will new loan improve applicant s financial condition? If credit card debt, what business purpose? Does refinancing include payments to creditors in a position to sustain a loss? Would the lender/sba be likely to sustain part or all of the same loss by refinancing the debt What portion of the total loan is refinancing? 32 Change of Ownership = New Business Lender s documentation must include: Business valuation (excluding R/E) Loans < $250,000 lender valuation okay unless close relationship between buyer and seller Loans $250,000 000 or more OR close relationship qualified independent 3 rd party required Real Estate Appraisal (if R/E transfer) Site visit Report Analysis showing how change of ownership will benefit the business not seller or buyer 5(G), pages 115-117 33 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 11
Change of Ownership Is and outsider buying the entire company? If yes loan eligible Is an outsider buying a partial interest in the company? If yes NOT eligible Is a current owner selling interest to remaining owners? If yes loan eligible Is an outsider buying substantially all of the assets of an existing company? [ asset sale ] If yes loan eligible 34 Final Comments Documentation in your file is all SBA has to rely on when determining that you acted prudently Key to successful SBA lending is fully addressing all SBA requirements, and maintaining documentation in file to back-up your conclusions 35 Copyright 2015, NAGGL, Inc. - Do Not Copy/Distribute 12