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SBA Hot Topic Tuesday – SBA Denys 7(a) Guaranty for Faulty Cash Flow Underwriting

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April 1, 2014

By Bob Coleman
Editor, Coleman  Report

SBAOIGPart 2 of 3 of our coverage of the January 2014 SBA Inspector General audit denying three SBA 7(a) guaranties.

Today, Florida Community Bank is the OIG target of an early-default loan of 10 months. Florida Community Bank had acquired the loan from the failed First People’s Bank in Panama City, Florida.

Herndon purchased the guaranty in May 2011 for $685,691.The OIG disagreed with the purchase and recommended the guaranty denial. Herndon disagreed with the denial, but was overruled by SBA senior management.

Writes the OIG, “If the lender’s financial analysis demonstrates that the Small Business Applicant lacks reasonable assurance of repayment in a timely manner from the cash flow of the business, the loan request must be declined.

“The lender’s analysis showed the borrower’s company was insolvent. Specifically, net income for the business had declined from $947,424 in 2006 to ($816,624) in 2008. Further, net income for the next 12 months of operations was projected to be ($671,041).

“The survival of the subject company was largely dependent on working capital from the SBA loan to sustain the company until the housing industry recovered.

“However, there was no industry market analysis, support for pro-forma revenue projections, or evidence that the distributed working capital would be sufficient.

“In 2008, First Peoples Bank refinanced all outstanding debt in the approximate amount of $3 million.

“As a result, the lender was at risk of substantial loss if the business failed. The business’ Debt Service Coverage Ratio (DSCR) for three years prior to the approval of the SBA loan was (0.65), (0.40), (1.31), and for the pro-forma was (1.07).

“The lender’s analysis did not predict adequate ability to service the debt until 2012, approximately two and a half years after the SBA loan was approved.

“Further, the lender’s credit memorandum stated that $200,000, or 76 percent of the company’s existing cash held as collateral, would be used to pay down the business’ outstanding debt to First Peoples Bank once the SBA loan proceeds were disbursed. This was further evidence that the business was having trouble paying its existing debt.

“Finally, as the proceeds from the SBA loan would serve to replace the $200,000 of business cash used to pay off the lender’s outstanding debt, this transaction could also be considered a transfer of risk from the lender to the SBA.”

Read the SBA OIG Audit: “Purchase Reviews Allowed $3.1 Million in Improper Payments on 7(a) Recovery Act Loans”

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