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Lending: Banks Worry about SBA's Guaranty

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Borrowers Look to SBA for Help

Marginal Applicants Need Not Apply


"SBA and all the good things that you say about them are a lot of crap," Wendall Burton told me after reading my column about lending programs specifically targeted to veteran borrowers. "Maybe you should do a column on all the people that the SBA won't help."

Burton is one of many struggling small-business owners that wonder if the U.S. Small Business Administration's rhetoric matches its deeds. After running a business in Southwest Florida for four years, he was denied a SBA Patriot Express loan.

In part it is because the agency does not have control over the banks and other approved lenders that make SBA loans. Even though SBA could have guaranteed 90 percent of the loan against default, Burton says, "I seriously doubt any banks will have much to do with me."

Here is the myth: SBA will slap a 90 percent guaranty on your loan and payoff if the borrower defaults. But in reality SBA would rather slither out of its guaranty and leave bewildered lenders holding the bag.

Virginia Medici Wylly sues SBA when it wrongly refuses to honor its loan guaranty. She is a lawyer with Lamb and Barnosky in Melville, N.Y. "Right now, the Agency is under pressure to get the money out to the public," she says. "In subsequent years, it will be under pressure to recoup taxpayer dollars."

Wylly was previously employed by SBA's inspector general's office. For those 20 years, her role was to find reasons for the agency to deny its guaranty on defaulted loans. "I examined the loans submitted for guarantee and did my best to be fair; but there were numerous repairs and several denials of liability," she says. "Even the most well-meaning lender could have trouble interpreting and applying the regulations."

On April 30, the I.G.'s Debra S. Ritt authored a memorandum outlining how "To reduce the risks associated with the extraordinary level of Recovery Act funding" by increasing oversight of SBA lenders and recommending when to void or repair its guaranty. "Because the higher guaranties reduce lender risk, which may lead to poor underwriting, a greater potential will exist for losses and fraud," Ritt's memorandum says. Moreover, it beefed up its staff to do more audits.

The result is that SBA's lenders make conventional quality loans and relegate weaker applications to the trash heap. Even the 100 percent guaranteed "ARC loans" meant to rescue small-business owners that are temporarily struggling, has been an abysmal failure. It provides up to $35,000 for small-business owners to reduce existing debt. SBA pays the interest and loan fees. Payments of principal begin 12 months hence.

I am concerned that a business can belly-up during the 12-months prior to payments are made and before the lender becomes aware of problems. So I asked SBA's Mike Stamler if the agency will void its guaranty in such a case. "Jerry, you really have to be deliberately misunderstanding this," he answered. "Or are you just screwing with me? Or are you still trying to give cover to lenders who won't make these loans?"

Apparently he did not like my question or my previous articles about ARC loans. Stamler would rather have me write that this poorly conceived program is working. In a more civil follow-up response, he explained that, "We require the lender to service the loan, and part of that is being aware of whether the business is still operating."

To prevent SBA from voiding its guaranty, lawyer Wylly says, "If you can find a lender brave enough to make an ARC loan, I would recommend that the lender keep in touch with the borrower at least every 90 days. This may mean a field visit or request for interim financials."

But SBA's Stamler says, "Failure to detect the closing of a business during the 12-month period won't impact the SBA's guarantee decision."

Wylly retorts, "If the business goes out in the 12 months following an ARC loan, someone (at SBA) will say that the business was not viable when it received the ARC loan," she says.

The guaranty could be in jeopardy if that happens.

SBA's loan programs are less effective because lenders fear may find a reason not to honor its guaranty. "The guaranty became less of a guaranty and more of a contingent liability," Wylly says.

Jerry Chautin is a volunteer SCORE business counselor, business columnist and SBA's 2006 national "Journalist of the Year" award winner, He is a former entrepreneur, commercial mortgage banker and business lender.