A primary cause of concern among many banks today is the high rate of default on government agency guaranteed small business loans like Small Business Administration (SBA), Farm Services Administration (FSA) and Farmers Home Administration (FMHA) loans. In the good ’ol days, when these loans hit 90 days past due, the bank simply filed a claim, sent the government agency the credit file and the agency took it from there.
Now, the agencies expect lenders to work out the credits themselves before filing claims. And for claims filed, the agencies expect documented evidence of lender due diligence in every aspect of loan origination and monitoring before they will honor their guarantee.
The fact is, guarantors have never rushed to write checks and, with federal budget deficits soaring, it’s not a stretch to say that government agencies are looking for more reasons to say “no” to the payment of loan guaranties. In this environment, lenders must make sure they are dotting every “i” and crossing every “t” when it comes to loan origination and monitoring procedures.
Due Diligence Required
Just because you have a loan guarantee doesn’t mean you can book a loan and forget about it. Far from it. The agencies expect you to perform the same due diligence on government guaranteed loans that you perform on non-guaranteed loans. Due diligence steps you can take to help ensure that guaranties are paid when government guaranteed loans go bad include:
- Obtain current and timely financial information from borrowers. You should be able to demonstrate that such information was obtained prior to underwriting the loan and periodically throughout the lending relationship, and that you appropriately monitored and analyzed the data.
- Conduct periodic site visits. When it comes to monitoring the true health of your borrowers, there’s no substitute for sitting down across the desk from them eyeball-to-eyeball and walking through their facilities to see for yourself what’s really going on.
- Monitor customer concentrations. A high concentration of sales (e.g., 50 percent or more) with one or a small group of customers should almost always be a cause for concern with small business borrowers. If this single customer is lost, the business’ future will be in serious jeopardy.
- Monitor growth. Is the business growing at a rate that’s sustainable over the long term? Is it adding profitable new customers, as opposed to just adding more customers for the sake of growth?
- Stay current on the agencies’ SOP manuals. Government agencies’ standard operating procedure (SOP) manuals change periodically, and not being aware of key changes could jeopardize your loan guarantee.
- Be proactive. Small business loans rarely sour overnight — signs of distress are usually evident three to five years before a loan defaults. Agencies want to see indications that you recognized signs of deterioration and were proactive in dealing with them well before the loan went bad, rather than waiting until payments were past due and it was too late to salvage the credit.
- Track how loan proceeds are being used. If you loaned money to support receivables, the business shouldn’t be using it to buy real estate, for example.
The importance of thorough documentation cannot be overemphasized. As far as government agencies are concerned, if it’s not in the file, it didn’t happen. Therefore, lenders should include written memos and other appropriate documentation in client files to support every substantive conversation or event related to the credit — and especially those that document specific due diligence steps like the ones noted here.
– More Risk Reduction Steps –
Focus on contingent liabilities and global cash flow analysis. Be sure to examine all of the borrower’s operating entities — the failure of an entity you’re not even aware of could bring down the business you’re lending to.
Kick the tires harder on collateral. The proof is in the pudding. If a client pledges marketable securities, ask to see recent statements.
Emphasize debt service coverage. Nowadays, this is usually more important than collateral coverage.
Be wary of financial forecasts and interim statements. The crystal ball is foggier than ever. Take any projections that go out further than 2-3 years with a grain of salt.
To learn more about monitoring government guaranteed loans please contact us today.