Over the past several years, an increasing number of financial institutions become either U.S. Small Business Administration (SBA) 7(a) lenders or expanded lending within the SBA program. Although the benefits can be significant, so can the risks if lenders don’t understand program requirements or have experience liquidating SBA 7(a) loans. Accounting standards regarding the sale of the guaranteed portion of an SBA 7(a) loan are a significant—often unseen—operational and financial pitfall. This article offers a high-level look at the benefits, risks, and accounting considerations for lenders in the SBA 7(a) Loan Program.
SBA’s guaranteed loan program benefits small businesses by helping fund short- and long-term loans. With SBA involvement, lenders can loan small business owners the capital required to begin or expand their operations on terms consistent with their cash needs. The guarantee program facilitates the leveraging of SBA’s appropriated funds with private-sector capital, which increases the pool of funds available to small business owners. SBA hopes this greater accessibility to capital will promote a healthy, vibrant, and productive economy.
Lenders benefit from participating in SBA’s guaranteed loan program in a number of ways:
- Lending in excess of legal lending limit— In most cases, the SBA-guaranteed portion of a loan isn’t included when calculating the legal lending limit (subject to state banking laws) for individual or affiliated borrowers, thereby permitting larger loans than would otherwise be allowed.
- Assisting in new account development—By offering loans consistent with the useful lives of the assets being financed and the ability of borrowers to repay, lenders can attract customers unable to find longer-term loans from other lenders.
- Creating liquidity—The SBA-guaranteed portion of a long-term loan is saleable and a source of liquidity, a benefit for all lenders.
- Helping meet Community Reinvestment Act provisions—Participating in SBA’s guaranteed loan program improves local economies by fostering the growth of financed businesses and subsequent jobs created.
- Increasing profits—An active secondary market often exists for SBA-backed loans; taking part in it can generate noninterest income.
The primary risks involved in SBA 7(a) lending occur during the closing, servicing, and liquidation stages. Repairs—the lowering of the guaranteed amount—and denials of guarantees usually come during liquidation, due to the failure to appropriately obtain, verify, or document at or before funding and closing of the loan.
The leading causes of repairs and denials of SBA guarantees are:
- Lien and collateral deficiencies
- Unauthorized use of proceeds
- Liquidation deficiencies
- Undocumented servicing actions
- Early defaults (denial, if determined to be the reason for business failure)
- SBA loan eligibility (denial)