April 8, 2014
By Bob Coleman
Editor, Coleman Report
The lender’s credit memo stated, “The past two years of insufficient cash flow have caused deferred maintenance and past due taxes, both which will be remedied with loan proceeds.”
Uh oh. Not the type of analysis one learns in SBA Credit 101 which requires positive cash flow and does not allow payment of past due taxes.
Writes the OIG, “The loan file did not identify the amount required to become current on the borrower’s taxes or satisfy maintenance requirements. Furthermore, this statement suggests that cash flow had historically been insufficient to maintain the business.
“It is also important to note that the business revenue was the borrower’s only source of personal income. However, there was no mention of the borrower’s draw on the business income or how the borrower had been financing his expenses while the business suffered. Because the loan files were missing key financial statements, we were not able to verify the lender’s calculated repayment ability.
“Based on historical income information and statements made by the lender, however, we determined that it was reasonable to question the repayment ability of the borrower. This loan should not have been made and the SBA should not have purchased the guaranty without the required documentation supporting the lender’s conclusion of repayment ability.
“The tax returns for years 2006, 2007, and 2008 indicated a net business income of ($22,078), ($23,861), and ($11,034), respectively. The lender did not provide an income statement or statement of cash flows as required. Additionally, the lender used unsupported net operating income figures that conflicted with the businesses tax returns in their historical and projected debt service analysis.
“This is disconcerting considering the lender acknowledged within its credit memorandum that the business had poor financial recordkeeping and performance.”
The OIG also faulted the lender for a loan structure that enabled it to refinance same institution unsecured debt, in violation of SBA loan policies.
“By not following the SBA regulations pertaining to refinancing debt, the lender created a conflict of interest where the approval of the loan to the borrowers resulted in the fulfillment of a note held as security, which might not otherwise have been paid. In effect, the Bank swapped a loan that was unsecured for a loan . . . . that was secured, effectively transferring its risk to the SBA. This gives the impression that the lender viewed the risk of the borrower not being able to repay its debt as substantial enough to warrant a new, SBA-guaranteed loan.
The loan defaulted within 15 months from the first disbursement. Herndon purchased the loan on January 7, 2011 for $897,091.
SBA and Herndon agreed with the OIG recommendation for a full guaranty denial three years after the fact.