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Good Small Business Loan Underwriting: Hopes, Dreams and a Big Dose of Reality

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August 26, 2015

Walterby Walter McLaughlin
Coleman Report Contributor
Senior Vice President
Banner Bank

What’s the single most overused phrase said by borrowers when applying for an SBA loan? “My projections are conservative.”

They probably aren’t, and it’s your job to ferret that out. Borrowers invariably focus on the upside of the transaction while tending to pay short shrift to the other end of the spectrum. As the lender, you cannot afford to do likewise.

Underwriting an SBA loan requires the lender to appropriately balance the risks and rewards. After all, not only do you have to convince yourself, but there’s that pesky SBA looking over your shoulder as well. Although the guaranty will mitigate one or more risks of a small business loan, it will not protect against losses as a direct result of wildly optimistic projections or improper underwriting. That’s one of the main reasons why SBA pays extra attention to early defaults, which are defined in the 50-57 as non-payment, a long deferment or an event that causes the loan to be placed into liquidation status within the first 18 months.

The inference is clear: If the loan suffers an early default, there is a significant chance that the lender’s analysis of the hopes and dreams of the borrower was flawed.

By no means is that a certainty, however, as events outside of the borrower’s or lender’s knowledge can cause a loan to default. Regardless, it’s important to hedge against the risk of an early default – or a default at any point in the life cycle of the loan, for that matter – with solid underwriting.

Loans up to $350,000: SBA allows the lender to substitute an acceptable credit score (currently 140 or above) for a narrative on business and personal credit histories, historical and projected cash flow and the overall strength of the business. However, most lenders continue to analyze these credit factors anyway, as well as business history, management skills, owner/guarantor strength, pro-forma debt/worth, collateral, global cash flow and all eligibility issues.

Loans greater than $350,000: It’s expected that the analysis will delve deeply into the “subconscious” of the request. In addition to assessing eligibility, the write-up should illustrate the benefits of the loan, narrating the business history and recasting historical cash flow as appropriate. The strength of the management team must be thoroughly reviewed. Other credit factors should include fully-supported projections, pro-forma balance sheet generation (with the adequacy of leverage and working capital addressed), global cash flow and collateral analysis, and personal and business credit histories.

In the end, the reader should be left with the understanding of not only how you came to your decision, but why. As Aldous Huxley once said, “Dream in a pragmatic way.” That’s definitely the right approach for an SBA loan.

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