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Lender "Screws Up," Others Can Learn From Its Mistakes

Every bank has its own sweet spot for small-business loans and will look at your application somewhat differently. Find the right one and form a business relationship before applying.
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The U.S. Small Business Administration's inspector general has berated Banco Popular about its alleged indifference to the agency's rules and standard operating procedures. According to its July 13 audit report, "Banco Popular did not adequately assess each borrower's repayment ability when originating Huntington Learning Center franchise loans."

The audit was prompted by 10 out of 12 of the loans defaulting over an 18-month period. And because they were all partially guaranteed by SBA, IG barreled in to investigate if taxpayers' money was imprudently wasted. More specifically, they investigated Banco Popular's underwriting procedures with an eye toward voiding SBA's guarantees and demanding its money back.

The result of IG's audit has two lessons. The most obvious is a warning for lenders to follow SBA's guidelines and do extensive homework before approving loans. Secondly there are insider clues for small-business owners seeking financing. The report details the sources you need to know about to perfect your loan application and impress the loan committee.

Banco Popular is an SBA "Preferred Lender." That means it can approve and close loans without first submitting them to SBA for its partial guaranty against losses. But in reality, the agency's loan guarantees are conditioned on IG's audits of defaulted loans.

Christopher Evans, a lawyer with Pennsylvania-based Starfield & Smith, represents lenders when SBA denies its guarantees. He says lenders are "often justifiably concerned about whether a submitted file contains all of the requisite documentation to preserve the guaranty." SBA requires compliance with its voluminous standard operating procedures and frequent modifications. Moreover, IG audits have increased to prevent fraud and abuse under the 2009 Recovery Act to "manage the integrity and mitigate the risks of all SBA programs," Evans says.

In fact, IG recommended that SBA demand the return of the $2.1 million guaranteed portion of the loans that Banco made to Huntington franchise borrowers. The government watchdog says that SBA should, "seek recovery of the loan guaranties, less any recoveries," and impose additional sanctions on the bank. The recommended sanctions are punitive and the recoveries would be from the borrowers' assets.

IG recommended that SBA demand the return of the $2.1 million guaranteed portion of the loans that Banco made to Huntington franchise borrowers. It said that if Banco used reliable sources to verify the reasonableness of the borrowers' projections, the bank should have rejected all 12 Huntington loan applications.

Reliable sources, according to Craig Cuddeback, include "Risk Management Association, Bizminer, Dunn and Bradstreet." He is a volunteer business mentor with SCORE and advises his small-business clients to "search the Internet for business operating ratios; several free and paid sources."

He also says, "public companies must publish their financial information each year for stockholders." Public company's financial ratios can be compared to those of smaller companies.

Public companies post their financial statements in 10Ks annually, and 10Qs quarterly.

Motivated by the Banco Popular brouhaha, Charles Green presented a lenders' webinar called, "How to analyze borrower projections to ensure the validity of your SBA Guaranty." Coleman Publishing, a financial media company sponsored the August 3 webinar.

Green, a former bank president, consultant and author says, "Bankers analyze business financial statements and compare the results with the annual financial statement studies compiled for each industry by the Risk Management Association." With RMA as a baseline, "They also study how the business is trending and compare the financial statements year-over-year."

In his third edition of "The SBA Loan Book," Green writes that RMA's "financial statements are compiled and averaged to determine the median and mean of operating standards for every industry each year."

Business owners argue, however, that each business is unique and cannot be averaged. That is especially true of very small businesses where the lines between taxable profit, cash flow and owner's compensation are blurred.

Even so, RMA is a good starting point for lenders and loan applicants. Thus, knowing how close you are to RMA's financial ratios, and doing extensive market research to justify deviations, might be acceptable to your lender.

"You cannot research these figures too much," Green says. "Consult with non-competitors in similar markets to determine whether or not the projections are attainable."

In other words, Banco Popular should have checked out existing Huntington franchisees in locations with similar demographics. In that case, the bank would have known that the broker-generated projections were inflated, the IG says. More revealing, SBA lists Huntington as the fourteenth worst franchise in 2011 with 44 percent defaults. But the bank failed to check the list.

"The integrity and reasonableness of these projections are often the most important factors in getting financing," Green writes in his recently completed book manuscript, "Get Financing Now." McGraw-Hill will publish it.

Small-business owners must support the reasonableness of their numbers by explaining where they came from. That means including extensive footnotes and citing their sources for important line items -- especially when they deviate from RMA or whatever benchmarks their lender says he uses.

Sometimes the most credible numbers come from the bank's previously closed loans. So dependent upon your relationship with the loan officer, he may tell you what the average financial ratios are in his portfolio. Every bank has its own sweet spot for small-business loans and will look at your application somewhat differently. Find the right one and form a business relationship before applying.

Jerry Chautin is an award winning small-business columnist. He is a former entrepreneur, commercial mortgage banker, commercial real estate dealmaker and business lender. You can follow him at

This post has been modified since its original publication.

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