Tip of the Week

Lending Without a Net

Have you ever asked yourself “who can I call to get a second opinion on this, just to make sure I’m not crazy, that I’m interpreting the SBA regs accurately?”  You would be surprised how many folks in our business ask themselves this type of question nearly every day.  Let’s face it.  The good ole days of the SBA District Office that was just a phone call away, for anything from a specific eligibility call to a complex servicing or workout question, are gone.  Long gone.   And that’s not all bad; there was a lot of inconsistency and confusion in that system for lenders dealing with multiple offices.

Our clients tell us they enjoy having a “lifeline”, access to accurate, current information germane to their SBA lending operation.  Naturally, many of the issues that come up day to day can be handled routinely in house.  If you do this stuff long enough, you’re bound to pick it up and just “know it”.  What about the “too hard basket”?

For example, a lifeline client of ours recently contacted us about a specific issue that on the surface might be construed as a straightforward technical issue question which might could be researched easily enough. 

But we also often find that that “one simple question” actually is just the tip of the iceberg.  Underneath, after digging a little deeper below the surface, there are more questions.  Let’s take a recent example:

Lender:  The new SOP 5010 (see page 193) states that if the lender determines the viability of the business is dependent upon the employee or employees, life insurance is a must.  Is there is list as to which businesses are a must to get life insurance? I have a borrower purchasing a dry cleaner. Our argument is this borrower does not need a life insurance since dry cleaning is not qualified as a “special skill” job.  If the key person (in this case our borrower) is not able to operate this business, then it is easy enough to find a person to take over the operations. Is this a valid argument?  Because if this argument is true, then this could apply to gas stations, deli/teriyaki, smoke shops . . . most of the small retail businesses. What do you think?

sbaAccess:  For most small businesses, it’s viability is dependent on an individual; therefore, when making a SBA loan to a small business, this rule will come into play on most every deal.  When SBA uses the term MUST (versus “should”), then lender is on notice there is no option.  Must means must.  (Many will consider this question cut and dried, closed, over.)

Lender:  I understand the use of the word MUST in SBA regs and SOP.  However, what happens if my customer is considered uninsurable due to a pre-existing medical condition?   I appreciate the potential credit risks associated with banking on a key person who may not be around to make sure I’m paid.  But let’s assume we can appropriately get past this concern.  What if there are mitigating circumstances such as taking additional collateral over above being fully secured?  Is there any circumstance that you can envision that we could originate an eligible loan and not take key person life insurance?

sbaAccess:  Well, per the old SOP, your rationale would have been a very reasonable approach and would have been acceptable.  However, with the rewrite of the SOP 50 10 (version 5, effective August 1, 2008), the verbiage now reads MUST, which provides no leeway or flexibility on the part of the lender.  Our recommendation would be that you take a look at the ownership structure and what other “key” people might be available to “replace” the person who is uninsurable.  Is there someone else key to the viability of the business where it would make sense to take life insurance on them, instead?  SBA requires life insurance on each SBA loan (key people and the related viability applies to all small businesses).

Lender:  On this particular deal, the business is owned 100% by the father, who owns two sons.  Both sons are very involved in the operation of the company and it is assumed that this next generation is considered the owner’s succession plan, going forward.  Could we justify that the sons are “key people” and, therefore, could we require the insurance on them, instead of the 100% owner?

sbaAccess:  The SOP 5010 language says, “the lender must determine if the viability of the business is tied to an individual or individuals…  It does not say that the life insurance is required on owners only, per se.  If you really feel the sons are key people and that if the father dies, the business would continue on under the direction of his sons, then you should make that case in your file.  You could even have the father confirm that in writing showing the intent.

Lender:  Okay, that makes sense.  Do we have to insure the “key people” for a set amount (the loan amount?) or can we make the determination of how much insurance we require on each person? 

sbaAccess:  The SOP 5010 does say, “life insurance required must be consistent with the size and term of the loan.  The amount of collateral available to repay the loan in the event of the death of the borrower may be factored into the determination of the appropriate amount of life insurance.”

Lender:  Well, our loan amount is $1,500,000, with a term of 20 years.  Could we only require $500,000 life insurance on each son?

sbaAccess:  Two sons, with total insurance of $1,000,000 may actually be reasonable.  However, document your decision of why you think it is reasonable.  Is the amount required “consistent with the size and term of the loan”?  What other collateral is being taken to offset any risk?  Make your case and document it in your file.

Actually, this discussion went even deeper with even more specifics to the type of collateral taken on the loan and the approach the lender would take in justifying their decision to insure the sons.  What is great about a sbaAccess “lifeline” is that we can get into the specifics of the actual deal and dig as deep as you need us to until the issue become crystal clear.  Having the lifeline can be seen as an extension of your team – we become partners with you to bring an added layer of expertise and a fresh perspective.

Take the Right Approach

Brian Burke and Karen McHugh