Processing a 7(a) loan through the General Program can seem like a daunting task. The thought of an SBA Specialist combing through the intricate details of a loan and issuing an SBA loan screen out spurs questions of timing and often uncertainty about eligibility. A “screen out” is the official issuance of questions from the SBA Specialist reviewing the loan application. This can deter many lenders and borrowers from wanting to be involved in loan submissions through the General Program.
By understanding the top 5 reasons for SBA loan screen outs, lenders can effectively limit screen out questions and instill confidence in the timeline and closing. Ideally, executing in these areas will increase efficiency which will translate into faster closings, and positive relationships among borrowers, lenders and the SBA.
One way of looking at the top reasons is to break them down into two categories: Attention to Detail and Eligibility.
Attention to Detail
1. Credit Memo
Having a clear and complete credit memo, consistent with all other aspects of the loan package, is the first step a lender can take to minimize screen out questions. A complete memo should address the breakdown of use of loan proceeds, equity and seller financing with all applicable terms and uses. Secondly, the lender’s credit memo should address collateral with careful attention to SBA collateralization rates and requirements. Don’t forget that life insurance coincides with the collateral requirements. Thirdly, a lender’s credit memo should address SBA specific topics like credit elsewhere, shareholder debt, verification of IRS transcripts and credit topics including (but not limited to) assumptions and guarantor experience.
2. SBA Specific Forms: 1919 & 1920
The credit memo should then correlate exactly to the specific SBA Forms (1919 and 1920) required on every submission package. The 1919 and 1920 are familiar forms for experienced SBA lenders, however it is important to focus on details such as the adjust period, payment amount, use of proceeds and the eligibility information questions. Additionally, the 1919 needs to be reviewed carefully for potential misunderstandings or mistakes made by the guarantor(s).
Lenders should be sure to send in signed and dated financials (3 years if applicable), debt schedules and interims for the guarantor, borrower, seller and any affiliates. Determining when affiliate information is required can be challenging, so when in doubt, add an explanation as to why something may be missing or intentionally omitted.
In 2016, these top 3 reasons for SBA loan screens outs accounted for 46.3% of all loan applications that received screen out questions.
(Source: U.S. Small Business Administration Office of Capital Access)
Eligibility requirements are often missed, resulting in SBA loan screen out questions. In my experience, many of the eligibility-based screen out questions are directly related to change of ownership and debt refinance loans.
4. Change of Ownership
When completing a change of ownership package, pay close attention to three areas: valuation, purchase agreement and other financing. The valuation must support the purchase price as the SBA will not allow the financing of above and beyond the value of the business. The purchase agreement should be between appropriate parties and the purchase agreements must create a clean break (no earnouts or clawbacks). Finally, seller financing should be well defined so the SBA can quantify the effect on the cash flow of the business. The language in purchase documents can sometimes get a bit tricky, so when in doubt, consult an expert.
5. Debt Refinance
Debt refinance loans have their own set of rules that often require a deep review of the documentation. A lender must understand the collateral and use of proceeds associated with the original purpose of the debt. The lender is required to take the same collateral and ensure that the original purpose of the debt is eligible, or that any ineligible condition has been removed. Finally, unless a balloon payment or line of credit, the lender must prove 10% cash flow savings and that the debt to be refinanced is currently on unreasonable terms. Submitting a debt addendum (Addendum E) to the General Processing Center is a good way to ensure all the above is accounted for.
Eligibility requirements go far beyond these few items, but it is important to remember these are the most common areas that receive questions from the SBA. Attentive lenders that are able to focus on both the attention to detail and eligibility issues can avoid the most common SBA and USDA loan screen outs. The importance of thoroughness when underwriting and presenting a deal cannot be overstated. A thoughtful application process with a focus on documentation detail and deep eligibility analysis will increase efficiency and reduce screen outs.
About Windsor Advantage, LLC
Windsor Advantage is a Lender Service Provider that provides a comprehensive outsourced SBA and USDA loan department to lenders nationwide. Services are provided on a variable cost basis with no minimum volume requirement. Windsor also provides continuing training and technical assistance to lenders at no cost. Since 2010, Windsor has processed more than $1.5 billion in government guaranteed loans and currently services a portfolio in excess of $1.2 billion (as of September 30, 2017) for more than 75 banks across the U.S. Windsor Advantage is based in Chicago with offices in Indianapolis, Los Angeles and Charleston. For more information visit WindsorAdvantage.com.
About the Author: Since joining Windsor Advantage in June of 2015, Steven Perry has held a variety of roles. Over the past two years, Steven has packaged and closed over $100 million in SBA and USDA loans. Steven graduated from the University of Notre Dame with a degree in Finance. He can be reached at 312-763-3221.