Best Practices: The Importance of Providing a Detailed Narrative in the Credit Memo When Documenting Credit Elsewhere

The importance of documenting one’s credit elsewhere (“CE”) analysis cannot be overstated. Arguably, no other provision of the Small Business Act has come under closer scrutiny.  This is understandable, given that no applicant who may obtain CE on reasonable terms may participate in the SBA’s loan programs.  The integrity of the core concept behind the Small Business Act is that “no financial assistance shall be extended to an applicant who can obtain credit elsewhere.” Generally, 15 U.S.C. 631 et. seq.  Indeed, a review of the new SOP 50 10 5 (k)’s CE test, prepared in response to the Small Business 7(a) Lending Oversight Reform Act of 2018 (the “Act”), underscores the need for a detailed and thorough CE analysis.

Prior to enactment of the Act, “credit elsewhere” was defined as “the availability of credit from non-Federal sources on reasonable terms and conditions taking into consideration the prevailing rates and terms in the community in or near where the concern transacts business, or the homeowner resides, for similar purposes and periods of time.” 15 U.S.C. 632(h).  In legislating changes to the Small Business Act, Congress made small but significant revisions impacting the CE test.

Congress developed a more robust definition of “credit elsewhere,” one consistent with Congress’s intent and the present day realities of SBA lending. Today, the CE test requires not only the availability of obtaining credit on reasonable terms and conditions to the individual loan applicant from non-Federal sources,  it now specifically adds non-State or non-local government sources as well.  It is borrower focused.  Acceptable factors may include: (i) the business industry in which the loan applicant operates; (ii) whether the loan applicant is an enterprise that has been in operation for a period of not more than 2 years; (iii) the adequacy of the collateral available to secure the requested loan; (iv) the loan term necessary to reasonably assure the ability of the loan applicant to repay the debt from the actual or projected cash flow of the business; and (v) any other factor relating to the particular credit application, as documented in detail by the lender, that cannot be overcome except through obtaining a Federal loan guarantee under prudent lending standards. Emphasis added, 15 U.S.C. 632(h), as amended by Public Law 115-189, June 21, 2018.

Under the section of the Small Business Act which grants the U.S. Government the power to extend or guarantee loans, the Act added the following underlined language to the existing Credit Elsewhere provision:

“The Administrator has the authority to direct, and conduct oversight for, the methods by which lenders determine whether a borrower is able to obtain credit elsewhere.  No financial assistance shall be extended pursuant to this subsection if the applicant can obtain credit elsewhere…” Emphasis added, 15 U.S.C. 636(a), as amended by Public Law 115-189, June 21, 2018.

This specific authority to direct, and conduct oversight for, the methods by which lenders determine whether a borrower is able to obtain credit elsewhere is in addition to the oversight and enforcement powers given to the Office of Credit Risk Management by the Act.

Since the Act’s enactment, the Agency has undertaken the task of promulgating rules in the SOP 50 10 5 (k) which SBA deems necessary to implement Congressional intent. Moreover, other rules have been published for public comment (including a new personal resources test) and are currently under consideration prior to final adoption and publication.  Indeed, further revisions are expected to the Lender Supervision and Enforcement SOP 50 53 and the On-Site Lender Reviews/Examinations SOP 51 00 as well as the NGPC’s Guaranty Purchase Package Tabs, which are likely to require the inclusion of credit memos for all submissions, and which should therefore contain a detailed narrative discussing CE.

Lenders are encouraged to ensure that their current credit underwriting guidelines address the means and methods by which they determine and document whether a borrower is able to secure financing without obtaining an SBA loan.  Documenting in detail – and in a narrative – the loan specific personal liquidity of the 20% or more owners, spouses and minor children, and the acceptable factors in the SOP, will go a long way to achieving compliance with the SBA’s seminal CE test. For more information on credit elsewhere, please contact the attorneys at Starfield & Smith at 215.542.7070 or email us at info@starfieldsmith.com.