Best Practices: Underwriting and Documenting Working Capital Disbursements

SBA’s Office of Credit Risk Management continues to focus on the adequacy of lenders’ underwriting and documentation of working capital disbursements on their 7(a) loans.

Lenders are required to thoroughly underwrite the adequacy of a borrower’s working capital needs as part of its approval process.  An analysis of the Borrower’s cash flow cycle, including its needs for permanent working capital, should be thoroughly discussed and analyzed.  SOP 50 10 6 requires lenders to include an “[a]nalysis of working capital adequacy, at a minimum over the next 12 months” for each borrower obtaining a loan in excess of $350,000.  SOP 50 10 6, Part 2, Section B, Chapter 1., Subparagraph C. 2. A. i., g). Furthermore, for all 7a loans, regardless of size, SBA requires that “When 50 percent or more of the loan proceeds will be used for working capital, Lender must explain in its credit memorandum why this level of working capital is necessary and appropriate for the subject business”  SOP 50 10 6, Part 2, Section B, Chapter 1., Subparagraph C. 2. a. i., k) ii) and C. 2. b. ii. b.

SOP 50 10 6, Part 2, Section B, Chapter 5., Subparagraph D. 3. a. iii. requires SBA lenders to obtain documentary evidence that loan proceeds were used for their authorized purposes, and further notes that “[i]f the Authorization identifies working capital as a use of proceeds and those proceeds will be used to pay normal operating expenses (e.g., payroll, utilities, etc.), then the working capital disbursement does not need to be documented.”  This then is the rub: if a lender does not adequately underwrite the borrower’s need for working capital for “normal operating expenses” and then further does not document what the working capital proceeds were actually disbursed for, then the lender has failed to meet its burden to obtain evidence that loan proceeds were disbursed for their authorized purposes, the likely result of which is a repair of the guaranty.

OCRM has identified instances where lenders have not provided a comprehensive analysis of borrowers’ working capital needs in their credit analyses, and that some lenders appear to be using working capital allocations to make other types of disbursements (such as debt refinance, equipment purchases, etc.).  These discrepancies have raised concern with the SBA that working capital allocations may be being used to mask otherwise ineligible uses of proceeds, or that there is not enough oversight of working capital disbursements being made by lenders to ensure that proceeds are being used for eligible purposes.

In light of this feedback from OCRM, SBA lenders would be well advised to either ensure that they are thoroughly underwriting their Borrower’s working capital needs in order to demonstrate that the working capital allocation is for “normal operating expenses”, or lenders should begin multi-disbursing their working capital disbursements to borrowers with documentation for each such disbursement evidencing that the proceeds were used for eligible working capital purposes.  Failure to properly underwrite and document working capital disbursement can lead to audit findings and repairs or denials of you SBA guaranty.  For more information regarding SBA compliance matters, contact the attorneys at Starfield & Smith at 215.542.7070.