In last month’s article, we looked at the mission and original intent of the SBA. This background is helpful for understanding the lens through which the SBA determines eligibility and approval of loans.
Read on for answers to common questions about loan eligibility, approvals, timelines, and when/when not to pursue an SBA guarantee.
Is this loan eligible?
The SBA wants to help as many businesses as it can, so the list of eligible loan purposes is lengthy. It is easier to tell you what is not an eligible use of funds. When working with our clients on a new loan opportunity, we always want to ensure the loan is eligible as early in the process as possible. VITAL has developed a checklist that makes this process very straightforward and simple for all parties.
What is the very first thing we should consider?
The SBA is a cash flow lender – not a collateral-based lender. Therefore, the single most important and very first question you must answer is:
“Can the borrower realistically repay the SBA loan and all of its other obligations?”
The following is directly from the SBA SOP:
Lenders must analyze each application in a commercially reasonable manner, consistent with prudent lending standards. The cash flow of the Small Business Applicant is the primary source of repayment, not the liquidation of collateral. Thus, if the lender’s financial analysis demonstrates that the Small Business Applicant lacks reasonable assurance of repayment in a timely manner from the cash flow of the business, the loan request must be declined, regardless of the collateral available or outside sources of cash.
What does the SBA consider acceptable cash flow?
The SBA wants to see a debt service coverage analysis reflecting debt service coverage at a minimum of 1.15 to 1.00. There are some nuances in the way SBA calculates debt service coverage that may differ from your current calculations, but we can walk you through the proper analysis.
For a business more than two years old, the SBA will focus on the borrower’s historical cash flow matched against the proposed SBA loan debt service and any other obligations. The greatest weight will be placed on the most current financial performance.
For a business under two years old, the SBA will focus on the borrower’s projected cash flow matched against the proposed SBA loan debt service and any other obligations. Please be advised that the borrower’s projections should be thoroughly analyzed for reasonableness.
What are some examples of when to pursue an SBA guarantee?
1. A business that meets the minimum debt service coverage ratio, but is short on collateral.
2. A business that would benefit from extending the amortization of its current debt, and as a result, meets the minimum debt service coverage ratio.
3. A business less than two years old that has a good business plan and reasonable projections, but simply doesn’t have a proven track record.
What are some examples of when not to pursue an SBA guarantee?
1. A business that does not meet the minimum debt service coverage ratio.
2. A refinance of existing debt where there is the appearance of shifting a potential loss from the current lender to the SBA.
3. A business less than two years old that lacks a good business plan and/or their projections are not reasonable.
Will the SBA approve this loan?
Whenever someone asks me this, my first question is “Will your institution approve this loan?” My second question is, “If so, why do you believe you need a SBA guarantee?”
I ask these questions because sometimes lenders have confusion as to who ultimately bears the credit risk and makes the decision to extend credit with a SBA guaranteed loan.
Lenders should approach their credit underwriting from the perspective of: we believe this loan makes sense; is a good credit risk; and we would make this loan conventionally; however for (1) this reason or (2) these reasons we can’t prudently mitigate (1) this issue or (2) these issues without the additional assurance provided by a SBA guarantee.
Approval by the lender is the first step in the process, and approval by the SBA should be thought of more as concurrence with the lender’s credit decision.
If you determine that the loan is eligible, meets the Credit Available Elsewhere Test, and you can prove that the borrower can meet the minimum debt service coverage ratio requirements, there is a very strong likelihood that the SBA will agree to provide their guarantee. This, of course, assumes that you have followed all other policies and procedures set out in the SOP. This is an area where guidance from VITAL provides a great deal of value.
What do we have to gather?
From an underwriting information perspective, SBA loans can be thought of as business loans that require some additional forms to be completed. In general, you will need to collect “normal” underwriting information such as historical tax returns, historical business financial statements, agings of accounts receivable and accounts payable, projections, debt schedules, personal tax returns, personal financial statements, etc.
In addition to the “normal” underwriting information, there will be a handful of forms the borrower and guarantors will need to complete. VITAL uses state-of-the-art technology to assist our clients in providing them with detailed checklists to ensure nothing is missed in the information gathering process.
How long is this going to take?
In our experience, the biggest factor is how cooperative and responsive your borrower is. We understand the struggles your borrower faces when trying to balance work lives with gathering necessary loan information. To help borrowers, and ultimately, our lenders, we have developed a very easy to follow guide that walks them through the process at their own pace.
The second biggest factor is the quality and thoroughness of your credit memo. The SBA requires certain things to be covered in your credit memo. VITAL knows what the SBA requires, and we have developed a guide to walk our clients through how to prepare a fully SBA-compliant credit memo.
When clients follow our process and take our counsel, we have experienced very few, if any questions from the Loan Guarantee Processing Center, which allows your loan request to be processed quickly.
Working at VITAL has provided me an opportunity to really learn how the SBA works. It has also afforded me the opportunity to get to know professionals who have shared their wisdom with me. One of the biggest things I have learned is that no matter how long you have been involved in SBA lending, no one person has every answer to every situation. Therefore, it is incumbent upon us to seek out the right answers when questions arise, rather than just going with what makes sense to us. I like the quote below, as I believe it sums up what many of us struggle with on a regular basis.
“What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so” – Mark Twain.