In the midst of the pandemic, lenders are finding that some common collateral structures are presenting new challenges when it comes to Small Business Administration (“SBA”) due diligence requirements and credit underwriting. One such scenario is when a lender requires residential real estate to be pledged as secondary collateral. For certain 7(a) loans, the SBA requires that a lender take all available collateral until the loan is fully secured, including without limitation real property owned by business owners providing a guaranty for the 7(a) loan. As a result, many lenders require a guarantor’s primary residence to be pledged as secondary collateral on their SBA loans. Often the guarantor already has a first mortgage on the primary residence, thus placing the lender’s mortgage in second lien position. The 7(a) authorization boilerplate requires that the lender obtain written verification of the amount owing on the prior obligation and evidence that the prior obligation is current on payments and not otherwise in default. In gathering due diligence, the lender will most likely obtain a credit report and/or mortgage statement(s) to verify whether the guarantor is current on the first mortgage. Due to the pandemic and financial institutions’ desire to assist borrowers during this difficult time, it has become increasingly common for lenders to discover that the guarantor’s first mortgage is currently on deferment or forbearance. A lender may be concerned about how a guarantor’s need for a workout on their personal obligations could impact a business’ credit prospects.
When a lender discovers that the guarantor’s primary residential mortgage is on deferment, the first step should be to speak with the guarantor to obtain the reason for the deferment, the length of the deferment and the details of the deferment. The lender should also discuss with the guarantor the plan for resuming mortgage payments. The lender should request a copy of the most recent mortgage statement (if not already provided) and any deferment paperwork that outlines the terms of the deferment.
Once the lender has gathered all information and documentation, the lender will need to use a prudent lending standard in determining whether or not this will affect the borrower’s ability to repay the SBA loan. Per SBA Procedural Notice 5000-20042, SBA acknowledges that “prudent underwriting during the COVID-19 emergency includes taking into consideration the current and future effects the emergency has on business operations, cash flow and the repayment ability of 7(a) applicants.” Lenders should reference this Procedural Notice for additional information on factors to consider in underwriting the ability of a borrower to repay a proposed loan during this challenging time. As always, lenders should document their decisions in their credit analysis using as much detail as possible and retain all outside due diligence in its file. Navigating these new challenges in the face of uncertain times doesn’t have to mean guessing in the dark. Lenders should keep up with the latest guidance published by SBA to help lenders find the way to continue to support small businesses through this emergency.
For assistance with SBA lending matters, contact the attorneys at Starfield & Smith, PC at 215.542.7070 or visit us at www.starfieldsmith.com.