Best Practices: The Nuances of Documenting Credit Not Available Elsewhere

Before any lender may finance an SBA guaranteed loan, it must assure compliance with SBA’s “credit elsewhere test.”  Compliance is a critical eligibility prerequisite.  The test is foundational and one that justifies the need for SBA financing.  It is for this reason that SOP 50 10 6 includes very specific documentation requirements. See SOP 50 10 6 at pages 131 and 132. Accordingly, because proper documentation is mandatory to meet program requirements, an understanding of SBA rules and how to document compliance must be performed by SBA lenders. In this article, we will address SBA expectations and examine documentation methods.

Lenders must certify that each applicant does not have the ability to obtain some or all of the requested loan funds on reasonable terms from non-Federal, non-State, or non-local government sources, including from the lender itself, without SBA assistance – otherwise the loan is not eligible. Submission of the application to SBA by the lender is a certification by the lender that it has examined the availability of credit to the applicant, based its certification upon that examination, and has substantiation in its file to support the certification. In addition to the certification, the lender’s credit memorandum must demonstrate the specific applicant’s need for the desired credit, reasonable assurance of repayment, and must include the reason(s) why credit is not available elsewhere on reasonable commercial terms from non-Federal, non-State, non-local government sources. See 13 CFR § 120.101.  It is key to identify why credit is unavailable to the current applicant and provide detailed information to substantiate the lender’s analysis and provide specifics for the applicant’s industry, business, and current circumstances.

It is key that the lender include detailed information in the credit memorandum rather than providing a canned response which simply restates the following sources are unavailable or do not apply. If a lender has performed the proper analysis for a specific applicant, then the final step is to add this information to the credit memorandum. In this way, it is clear to anyone reviewing the credit memorandum – whether before or after the loan closes – how the lender reached this determination.

Every lender must include in its credit memorandum a determination that some or all of the loan is not available from any of the sources listed below:

1. The liquidity of owners of 20% or more of the equity of the Applicant, their spouses and minor children, and the Applicant itself; or
2. Conventional lenders or other non-Federal, non-State, or non-local government sources of credit including the lender (including any commitment by a third party to provide financial assistance to the applicant in the event of a delinquency or default on a payment such as a commitment by a franchisor or licensor to provide financial assistance to the franchisee or licensee).

The lender must substantiate that credit is not available elsewhere and discuss acceptable factors that demonstrate an identifiable weakness in the credit. The lender must include in its credit memorandum the specific reasons why the applicant does not meet conventional loan policy requirements, along with relevant supporting documentation. While a lender may cite the applicant’s inability to meet the lender’s conventional credit score policy as one reason that credit is not available elsewhere, it may not be the sole reason identified. The SBA has identified acceptable factors that demonstrate an identifiable weakness in the credit or exceed policy limits of the lender, but it is the lender who is responsible for explaining the connection between the applicant and the applicable factor by providing a detailed narrative.

These acceptable factors include:

1. The business needs a longer maturity than the lender’s policy permits to reasonably assure the ability of the loan applicant to repay the debt from the actual or projected cash flow of the business;
2. The requested loan exceeds lender’s policy limit regarding the amount that it can lend to one customer;
3. The collateral does not meet the lender’s policy requirements;
4. The lender’s policy normally does not allow loans to new businesses (e.g., a business that has been in operation for a period of not more than 2 years) or businesses in the applicant’s industry; and/or
5. Any other factors relating to the particular credit that, in the lender’s opinion, cannot be overcome except for the guaranty. These other factors must be specifically explained in the lender’s credit memorandum, and relevant supporting documentation must be included in the loan file. Examples of “other factors” may include business and personal credit history, management experience, leverage ratio, global cash flow, and loan size relative to the age of the business.

A lender’s failure to follow SBA guidance and document compliance with SBA’s credit elsewhere test poses eligibility risks for the lender. Insufficient documentation may result in SBA declining an application submitted under non-delegated processing or denying liability on the guaranty if the application is approved by a lender under its delegated authority. For more information on documentation of credit not available elsewhere, please contact the attorneys at Starfield & Smith at 215.542.7070 or email us at info@starfieldsmith.com.