By Jay Lucas, Porter Keadle Moore
The relationship between small businesses and local financial institutions is a vital component of a healthy modern economy. Institutions fund local businesses that in turn, employ local workers, sell goods to local consumers, and if they are successful, apply for additional loans to purchase new equipment or larger commercial space.
While most banks’ preference is to fund local business loans themselves, in some cases, a bank’s product offerings may not provide the right fit. In that case, there is another option available: The U.S. Small Business Administration, also known as the SBA. Since this federal guarantee program often provides more flexibility for the borrower, it allows community banks to approve loans that might otherwise have been denied based on the bank’s traditional loan policy — essentially providing small businesses with much needed working capital that otherwise would not be available to them.
SBA lending programs benefit both bankers and businesses alike. For small businesses, they can serve as an essential means to both present and future credit access, and small businesses that are highly leveraged (or have limited liquidity or collateral) may be good candidates for an SBA loan, provided they have a strong business operation in place or can demonstrate through financial projections the ability to repay the loan.
For banks, SBA programs provide greater flexibility to include additional offerings such as longer maturities, increased lending limits, or increased policy limits on the amount that can be lent to a single borrower. Similarly, SBA loans provide banks with the ability to offer loans to new businesses or emerging industries that might not normally be covered in the bank’s specific lending policy. All of this equates to higher approval rates and, potentially, increased profit.
Today, many community banks are finding SBA loans to be a productive source of funding, not only because of strong profit margins, but also due to income opportunities from either retaining servicing rights or the gain on sale assets from the secondary market. The level of extra liquidity that SBA loans provide makes them attractive for resale – freeing up capital allowing the bank to then make more small business loans. At the same time, holding SBA loans in an existing portfolio can allow bankers to better leverage their capital and reduce investment risk, as the guaranteed amount is usually subject to zero-percent risk weighting for capital purposes.
For bankers that elect to retain servicing rights, the Small Business Administration has strict rules and oversight in place, much of which relates to monitoring and reporting. The SBA manages the program through the legislatively approved Standard Operating Procedures (SOPs) governing SBA Loans. One key procedure is the requirement of a “PARRiS” review (Performance, Asset Management, Regulatory Compliance, Risk Management and Special Items), under which, if underperforming loans within these portfolios are discovered, bankers could risk losing SBA guarantees and become responsible for any loans deemed unsatisfactory.
The purpose of the PARRiS review is to help both the bank and the SBA ensure that the loan is in good standing, and that the business is maintaining proper operations. Each component of the PARRiS review is measured on both a quantitative and qualitative scale, with the former being established by the SBA’s risk tolerance data and totaled to produce a borrower’s PARRiS Score; and the latter applied to how the bank manages its SBA loan program, changes in loan policies, staff proficiency and other impactful areas the SBA deems worthy.
These reviews can also result in certain “flags” that highlight other areas that the SBA could continue to monitor as they assess a Bank’s level of risk. While these flags do not directly affect a lender’s PARRiS Score, they could play a role in their overall Review Assessment or even trigger additional, more targeted reviews. As is the case with any of its review protocols, the SBA may periodically revise any of these flags or factors. With the recent release of the SOP 50 10 5 (J), taking effect January 1, 2018, the new SOP sets forth changes to such items as: franchise agreements, management agreements, equity injection, the EPC rule, credit elsewhere and eligibility requirements.
Because of this, vigilant compliance is a necessity for any bank underwriting SBA loans. Financial institutions, in order to ensure the guarantees on their SBA loans, must plan for frequent and thorough credit and compliance reviews, as well as consider ongoing monitoring of the business itself to mitigate additional risks. Bankers should also consider working with experts in SBA lending compliance familiar with the unique challenges of these loan programs, who can provide end-to-end guidance for SBA SOP compliance and readiness.
Along with external expertise, bankers should also have the appropriate internal infrastructure in place prior to initiating an SBA lending program. It is critical to have a staff expert on hand with a clear understanding of the nuances of SBA lending – underwriting, monitoring, servicing and standard operating procedures.
SBA lending can provide direct results for banks by increasing revenue while mitigating risk, as well as other indirect benefits such as borrowers seeking other accounts and services with their banks (ex. cash management and payroll solutions). Overall, these programs can provide flexible solutions while allowing banks to be a catalyst for powering their local economies, which rewards the entire community.
Jay Lucas is the director of credit services for Porter Keadle Moore. He has more than 20 years of experience in the banking and financial services industry, where he has gained extensive knowledge in Risk Management, Organizational Restructuring, Commercial Lending, Business Finance, and Senior and Executive Level Management.
