Underwriting SBA 7(a) Loans in the Midst of the COVID-19 Pandemic

On August 7, 2020, the Small Business Administration (“SBA”) released Procedural Notice 5000-20042 (the “Notice”) to provide lenders with much needed guidance on underwriting SBA 7(a) loans during the COVID-19 pandemic. The text of the Notice can be found here.

The Notice, which is effective through December 31, 2020, discusses the additional credit analysis necessitated by the COVID-19 pandemic. Lenders are expected to continue to abide by SOP 50 10 5(K), which provides that each loan application must be reviewed in a commercially reasonable manner, consistent with prudent lending standards, and cash flow must be the primary source of repayment rather than the liquidation of collateral.

Additionally, loan requests must be declined in the event the lender’s credit analysis shows lack of reasonable assurance of timely repayment. This is true regardless of whether the borrower has collateral available or outside cash sources. The SBA further provides that prudent underwriting during the COVID-19 emergency includes considering the current and future effects the emergency has on business operations, cash flow, and the repayment ability of 7(a) borrowers. The Notice recommends that 7(a) lenders consider the following factors in their credit memorandum for new 7(a) loans made during the COVID-19 pandemic:

Does the borrower have any other loan(s) (PPP, EIDL, or other stimulus financing, etc.) that have repayment or contingent repayment requirements that could impact cash flow? If so, consider:
1. What is the loan’s status (on deferment, past due, for PPP loans forgiveness application in process etc.)?
2. What is the cash flow during and after any payment deferment period?
3. What will the cash flow be if the loan is fully, partially or not forgiven?
4. What lien position will the new 7(a) loan have?
Based on the sector and industry in which the borrower operates, how is the industry and the business impacted by the COVID-19 pandemic?
How have any restrictions such as “stay-at-home orders”, social distancing, travel, traffic flow, and trade limitations impacted the borrower’s cost projections, clientele or access to supplies, inventory, and/or equipment?
What are the other impacts to the business’ operational cost(s) such as providing protective gear, cleaning materials, and essential costs to ensure the safety of customers and employees?
Is the historical financial information reliable based on current market conditions? If not, consider using month to month financial proforma with break-even analysis based on current market conditions.
How concentrated or diversified is the customer base? How reliant is the borrower on sales to or receivables from customers in those concentrations?
How concentrated or diversified is the borrower’s vendor/supplier pool, and which, if any, vendors/suppliers have decreased ability to support the business?
Discussion of the impact current market conditions have on collateral adequacy.
For loans involving change of ownership, given current market conditions, does the borrower have adequate industry experience to operate the business? Consider whether the seller has loan(s) that have repayment or contingent repayment requirements that could impact cash flow. If so, consider Factor 1 and its subparts (a) – (d) above.
For any loans where 50% or more of the loan proceeds will be used for working capital, the lender should specifically address in its credit memorandum why this level of working capital is necessary and appropriate for the subject business in light of the COVID-19 pandemic.

This list of factors is not exhaustive. The SBA Attorneys at Lewis Kappes continue to monitor the developments to SBA programs as a result of the COVID-19 pandemic. For more information regarding the underwriting 7(a) loans during the COVID-19 pandemic or other matters related to the SBA, contact our Lending & Finance group today.

Christopher A. Poling: cpoling@lewiskappes.com
Scott A. Oliver: soliver@lewiskappes.com

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