Tip of the Week
What is "REASONABLE" and "PRUDENT"?
In May 2007, changes to the CFR's (Code of Federal Regulations) became effective which among other things resulted in broader delegation of servicing and liquidation authority to ALL 7(a) lenders and some CDC's (see PN 5000-1017). All 7(a) lenders are now charged with servicing and liquidating loans on par with what used to be only delegated to PLP lenders. There are catch-phrases in the new regulations that center around the terms "commercially reasonable" and "prudent lending standards".
Lenders have differing interpretations of these somewhat subjective terms. There are a number of reasons that understanding and utilizing delegated authority is essential:
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Lenders can save themselves the frustration and time delay of asking SBA to approve an action, only to be told it is within their delegated authority.
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The SBA Service Centers and National Guaranty Purchase Center are inundated with requests from lenders to approve actions that are in fact within delegated authority. Having to review and respond to these requests takes manpower away from those actions that appropriately require SBA's prior approval and slows down their operations.
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Customers are spared from being told "we have to get SBA's approval", when in fact the lender may have the delegated authority for what is under consideration.
In an effort to clarify some of the misunderstandings surrounding delegated authority, SBA published an updated notice on the topic in June 2009 (see PN 5000-1110) and has developed a "Servicing and Liquidation Actions Matrix" which gives all parties (lenders and SBA) a uniform basis from which to operate. However, that still doesn't define "reasonable" and "prudent".
13 CFR 120.535 states:
(a) Service using prudent lending standards.
Lenders and CDCs must service 7(a) and 504 loans in their portfolio no less diligently than their non-SBA portfolio, and in a commercially reasonable manner, consistent with prudent lending standards, and in accordance with Loan Program Requirements.
(b) Liquidate using prudent lending standards.
Lenders and Authorized CDC Liquidators must liquidate and conduct debt collection litigation for 7(a) and 504 loans in their portfolio no less diligently than for their non-SBA portfolio, and in a prompt, cost-effective and commercially reasonable manner, consistent with prudent lending standards, and in accordance with Loan Program Requirements and with any SBA approval of either a liquidation or litigation plan or any amendment of such a plan.
Maybe it will help to define what is not delegated to the lenders by considering what is in 13 CFR 120.536. Click here for servicing and liquidation actions that require the prior written consent of SBA.
It seems that the areas where lenders most often tend to get off track are:
(1) lender preference
(2) lack of appropriate documentation, and
(3) internal controls to evaluate and approve delegated actions
The first key is to DOCUMENT, DOCUMENT, DOCUMENT! Do not rely on memory to recall the details later on. Any material action - such as a release or exchange of collateral, release of a guarantor, subordination of an interest in some collateral (to name a few) should be thoroughly documented.
Putting Together a Loan Servicing Request
It could be as simple as developing a credit memo outlining the action, rationale for the action, how it will benefit the borrower (and not be to the detriment of the lender and/or SBA). For those actions which do not require SBA approval, the lender request should include:
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Statement of proposed action
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What make the request necessary (what's the impact on the business?)
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Loan status
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Financial statement analysis
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Loan collateral analysis (before and after the modification)
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Proof of consent of all loan obligors/guarantors
Then the action should be approved consistent with the lenders internal approval requirements, just as if it were a new extension of credit. Think in terms of taking the action to the "loan committee" for approval. Does the written documentation sufficiently explain and support the rationale such that a "loan committee" would readily approve it? In other words, is it "reasonable" and does it fit within "prudent lending standards"?
Also, be sure that the action does not in any way treat the lender's position preferentially to the interests of the SBA. The SBA is a stakeholder and must be treated equitably and fairly in all instances. This most often comes up in terms of collateral lien positions and application of proceeds in a workout or liquidation situation.
Finally, don't operate too independently. Have defined internal controls for reviewing and approving servicing and liquidation actions. In the "old days" when servicing actions needed to be submitted to the SBA for approval (and currently for those matters still requiring SBA's prior approval), SBA operated using the "Rule of Two" (see SOP 50 50, Chapter 2). An action required the approval of at least two people. One reviewed the request and came up with a recommendation and the second confirmed it. Lenders should operate similarly with delegated authority.
"Reasonable" and "consistent with prudent lending standards" are somewhat subjective terms. However, if lenders follow policies and practices for servicing and liquidation actions, such that they obtain at least one approval with authority above the recommending person (perhaps consistent with the hierarchy of lending approval authority), they should not run into problems down the road if/when a guaranty purchase becomes necessary.
If your organization is in need of guidance in formulating internal policies and procedures, please contact us. Also, if you have something that has already occurred and now it has been called into question, that might be a good reason to become a sbaAccess Lifeline client.
Take the Right Approach.
John Cumbey, Brian Burke and Karen McHugh
SBA Access ©2009 - All Rights Reserved
All content is copyrighted and unauthorized use is strictly prohibited. If you would like to quote any part of this text, email bburke@sbaaccess.com or kmchugh@sbaaccess.com for permission.
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