Banks Beware: SBA Will Begin Second Guessing Underwriting Decisions

September 14, 2012

by Matthew M. Maher

1258644_old_building.jpgSince the Small Business Jobs Act was passed in 2010, there has been a significant increase in both the number and the average size of Small Business Administration (SBA) loans. Yet while the SBA continues to encourage its national and regional lending partners to originate more SBA loans, two recent Advisory Memoranda issued by the SBA's Office of the Inspector General (OIG) make the invitation less palatable, as the SBA is about to apply much higher scrutiny to the underwriting practices of its lending partners. Indeed, the SBA loans is placing its lending partners on notice that, if these loans default, their underwriting decisions will be second-guessed and their ability to recover under the SBA's guarantee is not assured.

Historically, the SBA delegated underwriting decisions to its approved lenders and discouraged its loan specialists from second-guessing the lender's underwriters. In stark contrast, the proposed new policy will require the SBA to perform a "more extensive underwriting and eligibility review" that will factor heavily into whether the SBA will honor its guaranty on the defaulted loan.

The OIG's Advisory Memoranda, dated March 23, 2012 (Report No. 12-11R) and August 16, 2012 (Report No. 12-18), resulted from several audits of the SBA's National Guarantee Processing Center's (NGPC's) review of loan packages for early-defaulted loans of $500,000 or more. The first OIG memorandum concluded that the NGPC's limited, superficial review of lender underwriting was not consistent with statutory and regulatory authority, was contrary to SBA procedures, and had cost the SBA millions in guarantees that should not have been paid. The second OIG memorandum recommended, inter alia, that the NGPC strengthen its review process for high-dollar early-defaulted loans, in particular to verify compliance with SBA's repayment ability requirements.

The bottom line for banks that originate SBA loans is that from now on the SBA will look very closely at - and second guess - their underwriting decisions before honoring its guaranty.