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SBA Credit Scoring System Being Questioned By Regulators

March 6, 2015

By Bob Coleman
Editor, Coleman’s Small Business Lending Podcast

Bob Coleman: Hi, welcome to Coleman’s Small Business Lending Podcast, Friday, March 6th, 2015, sunny Southern California, 72 degrees, sorry to my friends back east. Today’s podcast is sponsored by the National Alliance of Commercial Loan Brokers Conference. That conference is also co-sponsored by BoeFly in Las Vegas. I will be the keynote speaker Tuesday, March 10th. I have a fun topic, it is broker fraud. If you are around please come up and introduce yourself and say hello. It should be a fun conference. They put together about 50 lenders, 250 brokers and it’s broker education, so this is important for the industry.

Several things happened this week. Last week my son, Joseph, and I were in Augusta, Georgia for the Georgia Small Business Lenders Conference. The keynote there was by SBA Associate Administrator, Anne Marie Melhum and I wrote speaking at the Georgia Lenders Conference in Augusta last week, Ann says we have a fairly new administrator, Maria Contreras-Sweet. She’s a community banker from California and she absolutely understands the challenges of smaller lenders. She’s highly committed to the success of the industry of small business lending. She’s renamed the SBA from Small Business Administration to Smart, Bold, and Accessible and she was pushing us every day to be smart, bold, and accessible.

What is a small SBA loan?

You, the lender, decides the amount of a small SBA 7(a) loan that can be approved with SBA’s credit score. This we wrote about on Wednesday. That is the takeaway I got from the Georgia SBA Lender’s Conference last week in Augusta. SBA continues to push lenders to approve more smaller loans. The agency understands the cost to the lender in underwriting smaller loans thus relaxed underwriting standards. Here’s the quick recap. SBA defines the small SBA 7(a) loan as less than $350,000. These small loans may be approved with SBA’s credit scoring system. You enter basic borrower information into E-Tran and a credit score will be issued. If it is above the minimal standard you may then approve the loan with reduced credit analysis and approved credit score assumes repayment ability of the business.

I want to repeat that. An approved credit score assumes repayment ability of the business. We’re going to talk about that later. However, the streamlined SBA credit memo requirements from your underwriters are one, a brief description of the management and the business and brief means brief. Number two, personal financial statements. Three, we do need the IRS Form 4506. I mentioned I’m speaking about fraud. To this day there are lenders who are still making loans without obtaining the 4506 to verify that what your borrower is telling you is what they are also telling the IRS. Four, analysis that equity and pro forma Debt to Worth ratios are acceptable. Five, proper verification of equity injection always key. Six, we need to list collateral and seven, we do need to do some type of global cash flow analysis if there are affiliated companies.

Now for the C-suite takeaway. You may choose a lower threshold amount to start processing loans with a small business credit score from SBA in order to feel comfortable with their system, say $50,000, and that’s what Ann Marie Melhum, the SBA Associate Administrator, said in Augusta. Start with a lower amount and see how it plays out. You may also choose to only process loans with a higher credit score than SBA’s minimum which is at 140. But the thing to remember, these are SBA’s minimum requirements. You are still the final arbiter of what is appropriate of what is prudent and you don’t have to go down to that low bar. You may say hey, even though we’re doing smaller loans we still want to do a cash flow analysis. We may not want to worry about current asset ratio and all those other ratios. Again the regs allow us to do acceptable ratios and we get to determine that it’s acceptable, so those are some foods for thought.

Now what’s interesting, I got two very astute feedbacks from bankers and let’s start with Washington Trust Bank, Doug Wolford. Doug, I appreciate your comments. Your article today speaks to SBA credit score on small deals. At the end you mentioned the lending institution could establish a threshold for credit approval above the 140 score. We actually were going to do this at the 160 level as this was identified at the lower end of the moderate risk banned by SBA. I understand this is called an overlay where in the bank establishes a higher standard using a credit scoring program. However, after meeting with the FDIC at a Portland District Office function and talking about our compliance department we abandoned the overlay idea due to a possible compliance violation.

FDIC said we had to continually understand and evaluate the overlay in order to justify it. As this is basically an unknown for us at the bank, we chose to use the 140 only to determine how we would process and not a credit decision tool due to regulatory risk.

Has anybody else had that experience or better yet, has anybody had – we’re bankers, we’re not statisticians. Has anybody had success in doing an overlay program that the FDIC has bought off? If you have had that experience please let me know and I’ll be happy to share it with everyone on our web site.

The next comment comes from my friend at Rhode Island, Brian Murphy, who is under tons and tons of snow as he said. And what they are saying is a similar issue but this, his regulator, the OCC, is pushing back on SBA’s scoring model and is treating these loans as substandard loans since the bank as the lender cannot demonstrate that the borrower, in fact, cash loans and I think that’s really critical. SBA is allowing the lender to say hey, we don’t have to do this if it scores okay. In this particular case with this community bank the regulator is saying uh-uh, we’re not going to allow that, so they’re not doing it.

So that’s a problem, he doesn’t want to be booking a bunch of substandard loans, so if he wants to do those smaller loans he’s being instructed to do cash flow analysis. What is your experience? How are other bankers out there dealing with this? I would appreciate your comments and I would like to start a dialogue on this topic, these two topics. Next we’re going to go to Brian and we’re going to talk a little bit more with him. Hi, we’re talking with Brian Murphy, President and CEO of Home Loan Investment Bank, Providence, Rhode Island. You guys have some snow out there, Brian?

Brian Murphy: Lots and lots of snow, heaps, we’ll send it out to you. There’s guys that are actually boxing it and shipping it.

Bob Coleman: Oh, Southern California it’s going to be 72 degrees today, so don’t hold that against me. Hey, we want to talk about a couple of things. It’s good to see you again, it’s been way too long. What’s the 3-2-1 program, what’s that about?

Brian Murphy: The 3-2-1 program, we have a credit matrix, so we pay up to three points to business referral partners. And I know you’re well-connected throughout the whole SBA lending community, so we’d like to get the word out that we’ll pay up to three points.

Bob Coleman: What type of deals?

Brian Murphy: Really we don’t limit by say a business industry type, but it’s more about we want 1.25 debt service. We sell the guaranteed portion to secondary markets, so prime plus 2.75, the best price you can get. We also do USDA B&I lending as well, so it’s more on the credit quality, not necessarily the industry. A good credit will pay up to three points.

Bob Coleman: Any geography restrictions?

Brian Murphy: East of the Mississippi, strongest in the Northeast, but anything west of the Mississippi would be an exception for board approval, but we’d still look at any good credit that’s all over the country.

Bob Coleman: Well, that’s certainly very attractive types of referral fees. I’m speaking next week to the National Loan Broker Association, so maybe I can drop your name for a plug from that standpoint in Las Vegas next week. The other thing I wanted to talk to you about, Brian, is we ran an article the other day that talked about SBA encouraging lenders to use their credit score, the SBA credit score, and by using that it automatically assumes certain things. It assumes the lender can do a lesser underwriting memo. They don’t have to do a Debt to Worth calculation, they don’t have to do financial ratios, it’s a streamlined process. However, you’re saying that your regulators are giving you negative feedback if you engage in that process.

Brian Murphy: Yes, we raised the issue a year ago when the $350,000 program was ruled out, the credit scoring model. We were discouraged then, we’re OCC regulated and they view it as substandard. We’re actually in the midst of a month-long OCC examination right now and we raised the issue again and again cash is king, debt service is the primary credit focus that they have. So under my impression there’s not a mitigating factor that can offset that from the OCC’s perspective.

Bob Coleman: That’s unfortunate. I know SBA is really being a disrupter in the field in terms of leading the charge at getting microlending to small loans out there. What I reported was hey, if you as the lender are uncomfortable of adopting SBA’s credit score of up to $350,000 then do a lower threshold, say start at $50,000. But you’re saying in your experience with the OCC even that is problematic, that they would simply go in and classify that loan as substandard right off the bat.

Brian Murphy: Yes, and that’s against our policy, so we’re not touching it. My fear is a few years down the road the Office of Credit Risk Management, the OCRM, would be very critical of that credit if it went bad and said why’d you do this loan and without debt service and we just don’t want to get burned.

Bob Coleman: Man, that’s too bad, that’s unfortunate. Brian Murphy, President, Home Loan Investment Bank, Providence, Rhode Island. Get your snow shovel out of the car and hopefully spring will be there soon.

Brian Murphy: Thank you. Yeah, we’re all praying for it.

Bob Coleman: And this concludes Coleman Small Business Lending Podcast for Friday, March 6th, 2015. I look forward to talking to you next Friday, thank you all very much.

Read More Ocean Capital’s 321 Commercial Loan Referral Payout Program
http://www.colemanreport.com/wp-content/uploads/2015/03/3-2-1-Commercial-Loan-Referral-Payout-Program-Expires-May-31-2015.pdf

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