EXPLORING THE NEW SOP 50 10 5(F) AND OTHER NEW SBA PROGRAM

INITIATIVES

W.P.A.S.G.L.Western Pennsylvania Association of SBA-Guaranteed Lenders

October 4, 2013

Agenda:

SOP 50 10 5(F)

Pending and recently enacted rule/policy changes affecting SBA lenders

Case Studies and Best Practices

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Definition of Good Standing Additional Guidance for SBLCs/CDCs Rewrite of Franchise Review Provisions Debarment Further Defined Changes to 912 clearance process ETran Submissions Only Refinance changes Credit Criteria different for two loan categories ($350,000 < >) Collateral policy: valuation methods and requirements for personally

owned assets Life insurance 147 Note and 148 Guarantee forms Application – 1919 and 1920 (replacing 4 and 4i)

Part ISOP 50 10 (5) (F) - Effective January 1, 2014

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Good Standing A lender must be in good standing with its state regulator and Federal Financial

Institution Regulator (FFIR) as determined by SBA. For purposes of participation in the 7(a) program, SBA considers a lender to be in good standing with its state/FFIR if it has satisfactory financial condition and satisfactory small business credit administration and servicing policies, procedures and practices. Accordingly, the lender’s written request to participate must include a written statement that to the best of its knowledge, the lender has satisfactory: i) financial condition (e.g., capital and liquidity); ii) small business credit administration policies, procedures, and practices that it continues to adhere to in its operations; and iii) small business servicing policies, procedures, and practices that it continues to adhere to in its operations. When reviewing good standing, SBA will look to see that a lender does not have significant deficiencies or weaknesses in these areas. “Significant” may be evidenced by the number or seriousness of the deficiencies, as determined by SBA in its discretion. SBA will verify any good standing statement where possible with public (e.g., Cease and Desist SOP 50 10 5(F) Orders and Call Reports) and/or non-public information from the lender’s primary and/or other regulators.

SOP 50 10 5(f) Subpart A, Chapter 1, II.C.c), pg. 7

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SBLC GuidanceSubmit credit policy to SBA consistent with

origination, servicing and liquidation requirements in SOP and CFR

Provide annual validation that credit scoring model is predictive of loan performance

Board must adopt controls over operations, programs and resources

Must demonstrate compliance with policies, procedures and controls

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CDC Guidance Each CDC’s board of directors must adopt and fully

implement an internal control policy which provides adequate direction to the institution for effective control over and accountability for operations, programs, and resources. The board adopted internal control policy must, at a minimum, comply with 13 CFR §120.826(b).

SOP 50 10 5 (F) Subpart A, Chapter 3II, B. 1.a), pg. 47

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Franchises Re-write of Review of Franchise/License/Dealer/Jobber or

Similar Agreement provisions

Rely on Certification of Franchisor

SBA will assist PLP lenders determine if affiliation exists for those franchises not on Registry Delegatedfranchisereviews@sba.gov

Although affiliation determination may be made by SBA on loans not on Registry, lender must still determine whether financing meets all other eligibility rules

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Get Executed Franchise Documents

If Lender disburses the proceeds without obtaining the necessary executed franchise documents, including any amendments and/or addendums, SBA may deny liability of guaranty.

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Gas Stations

Review Relevant Documents: Title Report Supply Agreements Franchise Agreements Purchase Documents

Look for: Repurchase Options Impairment of

Collateral Value Alteration of

Lender/SBA’s rights Subordination not

sufficient

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Business with An Associate of Poor Character

Subject Individual: Owner, partner, officer, managing member, owner of

20% or more, Trustor and day-to-day Manager Form 1919 – Questions 1, 2 & 3 If Yes to 1= Not Eligible If Yes to 2 or 3 = Find out more. Felony = Fingerprint Misdemeanor = Name Check or Fingerprint Send 912 to Field Office

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Business with An Associate of Poor Character

You can clear it! Maybe…PLP Lender or SBA Field Officer can clear the

following: Single minor misdemeanor offense or arrest; or Up to 3 minor offenses (arrests and/or convictions at

one tie or separately), concluded more than 10 years prior to date of the SBA application; or

A prior offence cleared by D/FA on prior application – valid for 6 months

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Refinancing Change of Ownership Debt

NOW Reads:

g) Debt used to finance a change of ownership;

But comments says:

SOP 50 10 5 (F) Subpart B, Chapter 1, IV, E. 3.g), pg. 115

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Additional Refi ProvisionsRefinancing Same Institutions Debt – 36 month

look back - late beyond 29 daysBorrower or Lender can get evidence from prior

lender of SBA loan for refinance7(a) to refinance 504 Loan – Both TPL and 504

refinanced or TPL paid in full, part of larger transaction

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Credit Criteria – Loan < $350,000

Current policy: Loans may be processed 7(a) , Express or SLA , etc. New policy: Loans $350,000 and under must be processed under SLA

Credit Score prescreening prior to submission of ETran application

If loan application does not receive an acceptable credit score, Lender may submit Standard processing or (if SBA Express Lender) an SBA Express Application via ETran for 50% guaranty.

Eligibility for SLA will continue to be based onpre-screening credit score and specified mandatory credit evaluation including that applicant’s debt service and global cash flow ratio exceeds 1:1 on a historical or projected cash flow basis

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Credit Criteria – Loan < $350,000

Lender’s Credit Analysis:

History of business Management experience Debt Service Coverage Ration exceeds 1:1 Projected Cash Flow Ratio exceeds 1:1 Owner/Guarantor personal financial statements, consistent with

similar non –SBA loans May use own credit scoring criteria Analyze strength of business – credit/deposit behavior Verify tax returns Equity and pro forma debt to worth are acceptable based on

Lender’s non-SBA loan policies

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Credit Criteria – Loans > $350,000.00Current policy: lender using delegated authority

makes own credit determination subject to requirement that business has ability to repay loan from its cash flow

New policy: lender must— Determine if repayment ability from business cash flow

exists AND Follow SBA-mandated credit evaluation criteria

INCLUDING minimum debt service coverage ratio of 1.15:1 based on a historical and/or projected basis

SOP Equity Injection requirements apply16

Credit Criteria – Loans > $350,000.00OCF/DS must be greater than 1.15 to 1.0 on

a historical or projected basis

Operating Cash Flow (OCF) as earnings before interest, taxes, depreciation and amortization (EBITDA)

Debt Service is defined as required P&I payments on all business debt inclusive of SBA loan proceeds

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Current Collateral RequirementsWith some sub-program specific exceptions, SBA

generally requires that – Assets financed by loan be taken as collateral AND Loan must be fully secured (based on liquidation value)

to the extent that collateral is available AND If business collateral insufficient to fully secure loan,

personal collateral of all types, including personally owned R/E, must be taken

Limited guaranty of spouse required if necessary to secure lien on jointly held R/E

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Collateral Requirements50 10 (5) (F)

At a minimum obtain a lien on the applicant’s fixed assets.

Lender may secure applicant’s trading assets (using a 10% current book value for the calculation) if it does so for similarly sized non-SBA-guaranteed commercial loans.

Loans between $25,000 to $350,000

Follow collateral policies and procedures that Lender has established and implemented for its similarly-sized non-SBA-guaranteed commercial loans

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Fully Secured means all available assets with a combined net book value up to the loan amount.

Fixed Assets, then Trading Assets (10% of current book value) and then personal real estate (up to shortfall)

Loans between $350,000 to $5,000,000

SBA requires that the lender collateralize the loan to the maximum extent possible up to the loan amount. If fixed assets do not fully secure the loan, the lender must take available equity in the personal real estate of the principals as collateral.

Collateral Requirements50 10 (5) (F)

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New Collateral Requirements

For loans of $25,000 and less – no collateral required

For loans over $25,000 – Lien on all assets financed by loan proceeds still mandatory

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New Collateral Requirements (Cont.) Liens on residence may be limited to150% of equity - if tax

implications from filing at higher amount Lien on personal residence still NOT required if equity less

than 25% Lien on jointly held R/E still required even if one spouse

has NO ownership interest in business – with limited guaranty required

No lien required if R/E wholly owned by non-owner spouse

Lien on other personally owned assets, e.g., stocks, bonds, CDs, etc., NOT required

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Life Insurance Current policy: lender has authority to decide whether to

require life insurance BUT if not required and principal dies resulting in a loss on the loan, SBA MAY DENY LIABILITY

New policy to allow lender to follow same policy that it uses regarding life insurance for its unguaranteed commercial loans of similar size and type

But, expectation by SBA that, on loans over $350,000 processed under the regular 7(a) program, sole proprietors, sole member LLCs, etc. must obtain life insurance unless loan is fully secured If principal uninsurable, lender must obtain written documentation

from a licensed insurer

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Other SOP Changes 147 Note and 148 and 148L Full and Limited Guaranty

forms no longer mandatory – be careful Lenders forms must contain SBA required clauses

Applications – Forms 1919 (Borrower) and 1920SX (Lender) Elimination of 4 and 4i Must use E-Tran for processing ALL loans

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Other SOP Changes504 Loan program changes in new SOP:

Does not require credit reports on non-guarantor affiliates

SBA can participate in Projects financed by obligations exempt form local or state taxes

Incorporates clarifications under 7(a) program (i.e. franchise reviews), permissible debt refinancing and change of ownership

Eliminates wet signatures on personal financial statements, balance sheets and income statements, fed tax returns and aging AR reports

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Part II

Recently Enacted SOP Changes and Rules Affecting SBA Lenders

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Recent SBA Procedural NoticesFRANdata Unique Numbering System (FRUNS) –

Starting October 1, 2013 Must submit a FUNS number for all franchise loans through ETran Control No. 2000-840

7(a) and 504 Fees – Starting October 1, 2013 Guaranty and on-going fees to be waived for all loans under

$150,000 beginning 10/1/2013 For other loans, on-going fee going down from 55 to 52 basis

points Control No. 5000-1288

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Change of Ownership

Co-Borrowers – adequacy of consideration

Asset Purchase, Stock Redemption and Stock Purchase

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OMB Circular A-129Credit Reporting Requirements (SOP 50 57 p. 30)Mandatory that lenders report SBA loans to a

commercial credit agency of Lender’s choice (quarterly)

OCRM will likely be looking for compliance in conducting its onsite reviews; and the position of NGPC is unclear

31 U.S.C.§3711Clarifying notice from SBA in process

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IPERA Audits

OIG report on SBA’s failure to comply with the Improper Payments Elimination and Recovery Act (IPERA)

SBA agreed to implement a payment recapture plan for approved loans, both before and after closing.

Do lenders close loans if audit pending? If deficiencies noted after funding, what should lenders do?

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Servicing and Liquidation PoliciesSOP 50 57 clarified to state that it only

governs loans after final disbursement has been made For servicing actions after initial disbursement, but

prior to final disbursement, lenders should still refer to SOP 50 10

New Matrix issued 4/30/2013New SBA Litigation Plan Tabs and Charge Off TabsSOP 50 55, Servicing and Liquidation SOP for 504

loans issued 9/5/2013

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Other Important Changes Affiliation and Personal Resources Rule policy revisions –

still under review – may be finalized before 1/1/2014 SBA One – part of requirements for fiscal and transfer

agent contract OCRM/OIG – Anticipated additional enforcement

initiatives (which could lead to more lenders losing PLP status or being removed from program)

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Part III

Case Studies on the Top Reasons for Repairs/Denials

Recommendations/Best Practices

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Case Study #1 - Eligibility Affiliation

Loan Structuring to exceed program maximums Lender failure to perform sufficiently detailed affiliation analysis FULL DENIAL

Ineligible Business Loan to purchase CRE and convert use to Brazilian Restaurant Existing use at time of closing – ineligible Lender failure to monitor UOP and change of use FULL DENIAL

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Case Study #2 – Improper PLP ProcessingLender refinance its own debt

$350k interim loan for equipment purchase SOP does not allow PLP processing to refi same lender

debt, unless an interim loan approved within 90 days of PLP #

Delay caused by fire Lender obtains PLP 10 mos. after interim loan approval

and closing $350k REPAIR

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Case Study #3 – Program IntegrityBank officer part owner of CRE developerBank approves loans to CRE purchasersPotential conflict of interest not disclosed to SBAFULL DENIAL

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Case Study #4 - Financials Early Default/Problem Loan Lender unable to produce 4506 Transcripts Logic conundrum – difficult to prove a negative Often lenders underwrite Change of Ownership as startup

when seller refuses to provide financials – beware! “Materiality” standard is not always followed FULL DENIAL

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Case Study #5 – Environmental

Gas station loanEnvironmental consultant recommends additional

testingLender does not require additional testingContamination at default

Lender cannot prove CRE was “clean” at closingREPAIR – cost of cleanup

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Case Study #6 – Use of Proceeds

Lender has burden to prove proper UOPLender does not reallocate proceeds in LAProceeds designated for one purpose used for

another purpose (i.e.: inventory $ used for working capital; renovation $ used for debt refi., etc.)

REPAIR i/a/o improperly disbursed proceeds

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Case Study #7 – RefinanceLender refinances several debts of Borrower

Ineligible purpose – 1 debt refinanced financed the buy-in of 1 principal“Creeping control” – ineligible

Ineligible debt – same debt was also owed to SBIC

REPAIR i/a/o line item allocated to refinance the ineligible debt

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Case Study #8 – CollateralLien PositionGuarantors

Application: Ownership 41%/41%/18% Operating Agreement: 33.3%/33.3%/33.3% Lender failed to verify ownership “18%” owner actually owned 1/3

Guaranty requiredIndividual has means and refuses to share financial info.

REPAIR? DENIAL?

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Case Study #9 – InsuranceLife – loan to sole proprietor

Failure to obtain life insurance Borrower dies REPAIR i/a/o loan balance less collateral recovery

Casualty – Acord Certificate Failure to get copy of binder Insurance company contests claim for coverage after

fire destroys business REPAIR i/a/o difference between replacement cost and

litigation settlement amount

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Case Study #10 – 912 Issues Principal answers “No” to questions 7, 8 & 9 on 912 Form Principal convicted of 2 misdemeanors (sexual assault) in

1993 and had felony arrest (battery) in 2002 (charges dropped)

Lender performs criminal background search prior to closing – no records found

Lender discovers misrepresentation on subsequent conventional loan application

What should the lender do?

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Recommendations/Best PracticesBegin with the end in mindSubmit “close calls” for GP processingUse 10 Tabs as post-closing audit checklistEngage in a compliance mindset in each phase of a

loanConstant improvement in front-end practicesAvoid “GIGO”

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Thanks! Any Questions?Kimberly A. Rayer, Esq.krayer@starfieldsmith.comP: 267-470-1208

1300 Virginia DriveSuite 325Ft. Washington, PA 19034P: 215-542-7070F: 215-534-9023

www.starfieldsmith

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