In several due diligence efforts recently, Ardmore identified a need for community and regional banks to review their SBA portfolios to ascertain if they are following the current SBA Standards of Procedures (“SOP”). Too many banks believed they reduced their credit risk of a borrower by obtaining an SBA guaranty, only to find out that the guaranty was negatively affected by non-compliance with the SOP.
Ardmore believes that SBA programs are an acceptable and valid form of lending for banks that have the skills, experience, and processes to perform them properly. The banks that do not display these attributes have an increased risk of loss due to inadequate administration and credit risk. Unfortunately, this has caught several banks off guard when their guarantees were not honored or were limited by the SBA due to non-compliance.
Typically, banks request an SBA SOP compliance audit for several reasons, including the sale of the bank due to a merger or acquisition or for their own originated portfolios in order to evaluate any process weaknesses.
Generally, auditors will review credit memos, loan authorizations, notes, guarantees, tax returns, risk rating reviews and other critical areas of the loan file to determine if there are material errors in the forms and process areas but mostly to get an outside opinion of the validity of the SBA guarantee. In other words, if the borrower defaults, is the guarantee still valid?
When an SBA lender asks the SBA to honor its guarantee, the burden of proof is always on the lender to prove that any documentation or process deficiency is not material and did not cause the failure of the business. The SBA has several options including repairing the guarantee or denying it all together.
The top reasons for partial repair or full denial from the SBA are the following:
Failure to obtain the proper lien position, failure to perfect security interest, failure to fully collateralize the loan at origination when additional collateral is available (generally a repair).
Unauthorized use of proceeds such as proceeds disbursed for purposed inconsistent with the loan authorization or subsequent modification without business justification (could be repair or denial if early default and the improper use of proceeds caused the failure of the business).
Liquidation deficiencies such as failure to conduct site visit which resulted in missed recoveries, improper safeguarding or disposition of collateral which resulted in missed recoveries and misapplication of recoveries to conventional loan when SBA loan has lien priorities (generally a repair unless harm is the full value of the outstanding balance).
Undocumented Servicing Actions such as liens not properly renewed, release or subordination of collateral without documented business justification, allowing hazard insurance to lapse on major collateral that was subsequently destroyed, and failure to maintain life insurance on principal and principal subsequently dies (generally a repair).
Early Default issues such as missing or unsupported verification of equity and verification of borrower financial information with the IRS where the information was relied on in lenders credit analysis (denial if determined to be the reason for business failure).
SBA eligibility issues such as ineligible businesses, ineligible loan purpose, and ineligible loan recipient (denial).
In cases of repair the SBA and bank agree to a specific dollar amount that will be deducted from the purchase amount to fully compensate SBA for the actual or anticipated loss caused by the lender. Denials allow the SBA to be released from its guarantee in full or in part for any reason set out in the CFR or SOP. Generally the SBA only denies liability when the bank’s actions or omissions caused or could cause a material loss to the SBA. However, the SBA may deny the guarantee in the absence of material loss if the lender’s misconduct is deemed material to the soundness or integrity of the loan program. This is especially true if the loan was ineligible or the lender failed to disclose or misrepresented a material fact to SBA or the lender breached SBA’s conflict of interest regulations.
Ardmore continuously expands and updates its SBA SOP Compliance auditing services, which we have been providing to banks for years, to help banks assure they are in compliance with the current SBA regulations and guidelines limiting any reduction in the SBA guaranty.
Our services include ongoing quarterly audits for existing bank SBA portfolios for potential guaranty issues and compliance reviews for banks seeking to acquire other portfolios through acquisitions or purchases.
Ardmore’s area of focus includes, but is not limited to, eligibility, credit standards in underwriting, collateral appraisals and environmental policies, loan authorizations, SBA loan policy development and or a GAP analysis on existing policy, closing and disbursements, and the servicing operation.
Commonly, the scope of work includes:
Providing bank management with an objective analysis regarding the quality of the bank’s SBA loan portfolio, the adequacy of the administrative function, and the supervision of credit risk for the SBA portfolio;
Identifying any gaps or weaknesses in the SBA policy, underwriting, funding and servicing of the SBA loans that are non-compliant with SBA regulations and could present a risk that the SBA will not honor its guarantee;
Evaluating the performance of the portfolio against norms in the industry;
Evaluating the bank staff, processes and systems for adequacy in managing the existing portfolio and potential growth; and
Making recommendations for improvement in staffing, policies, processes, and systems to enhance credit risk management for the SBA portfolio.
Ardmore’s Senior Consultant, Doug Hood, has performed all the critical functions in underwriting, closing, funding, administering, liquidating, and auditing SBA loans for over 35 years. Doug is a former banker specializing in SBA loans and was the Southeast Sales Manager for AT&T Capital (formerly one of the largest SBA lenders in the U.S.). He has been a trusted advisor and auditor on SBA loans for numerous banks on the Eastern coast, Mid-Atlantic and Mid-Western United States. Doug has served on the Georgia and National SBA Advisory Council and has received awards from the U.S. Small Business Administration.
Ardmore believes banks should be prepared and not surprised by the SBA responses to their guaranty requests when a credit is deteriorating.
If we can help assure your portfolio is in conformance with guidelines, and unfortunately many are unknowingly not, please contact us for a quote on services.