On March 21, 2002, the OIG issued Audit Report 2-13, Audit of an SBA Guaranteed Loan to CFM Bracket Company, Inc. The objective of the audit was to determine if the lender originated, disbursed, and liquidated the loan in accordance with SBA rules and regulations. The subject loan was reviewed for compliance with 11 requirements found in SBA rules and regulations, and the SBA-lender guarantee agreements. All identified lender deficiencies were evaluated to determine if a material loss to the SBA resulted. A material loss was defined as exceeding $25,000.
The SBA is authorized under Section 7(a) of the Small Business Act to provide financial assistance to small businesses in the form of government guaranteed loans. The SBA guaranteed loans are made by participating lenders under an agreement to originate, service, and liquidate loans in accordance with SBA regulations, policies, and procedures. The SBA is released from liability on a loan guarantee, in whole or in part, within SBA’s exclusive discretion, if a lender failed to comply materially with SBA regulations, the Loan Agreement, or failed to make, close, service, or liquidate a loan in a prudent manner.
Heller First Capital Corporation (the lender) was a Small Business Lending Company authorized by the SBA to make guaranteed loans under the Preferred and Certified Lenders Programs. Under the PLP Program, participating lenders are permitted to process, close, service, and liquidate SBA guaranteed loans with reduced requirements for documentation to and prior approval by the SBA. Under the program, loan guarantee applications and servicing actions are processed by the SBA on a priority basis. Heller First Capital Corporation stopped making SBA guaranteed loans in February 2001 and was purchased by General Electric Capital Corporation on October 25, 2001.
Prior audits of early default loans found that the lender did not always materially comply with SBA rules and regulations. In a January 2000 response to one of the audits, the lender acknowledged that the loan, which closed in 1997, would not have been approved under its current underwriting and closing procedures. A few months later, in response to a PLP review, the lender admitted that combined growth in volume and processing locations across the country was not in its best interest or SBA’s lending program. Consequently, certain regions exercised more discretion in both credit analysis and compliance with procedures than the lender would have liked.
Based on the lender’s acknowledgement of the lack of controls over the SBA guaranteed loan process, the Office of Inspector General initiated an audit of all loans originated by the lender that were purchased by SBA between January 1996 and February 2000, to determine if the loans were processed correctly. The audit determined that multiple loans were originated, serviced, and liquidated in material non-compliance with SBA rules and regulations. One of those loans went to CFM Bracket Company Incorporated and is the subject of this report.
In December 1997, the lender approved an SBA guaranteed loan for $150,796 to CFM Bracket Company, Incorporated under PLP procedures. The borrower, CFM, was a start-up business that planned to manufacture a bracket for photo-sensing equipment for use on luggage conveyer systems found at airports. The primary purpose of the loan was to refinance seven other loans totaling $70,761 that were obtained by the borrower from two other banks and a private source. Additionally, the proceeds were to be used for making real estate improvements of $37,754, purchase machinery and equipment of $34,937, and provide working capital of $7,345. The last loan disbursement occurred in December 1997. The borrower defaulted on the loan in June 1998, after making only 1½ payments totaling $2,375. The loan was placed into liquidation in August 1998, with the SBA purchasing the loan guaranty for $116,722 in September 1998.
The OIG found that the lender lacked support for the borrower’s repayment ability and did not exercise reasonable care in protecting SBA’s financial interest by using unsupported information to evaluate the borrower’s repayment ability. According to SOP 50 10 (4), the ability to repay a loan from the cash flow of the business is the most important consideration in the loan making process. However, the lender used a breakeven sales figure of $600,000 to calculate repayment ability. The loan analysis in the loan file provided the following information did not support the analysis of the borrower’s repayment ability.
The OIG also found that the lender did not take prudent measures to ensure that the borrower injected equity of $43,329 into the business as required. Evidence of the equity injection consisted of copies of 74 cancelled checks totaling $35,191 and 22 receipts for construction and various other expenses for $7,484. The checks, however, were drawn on the same bank accounts used by the borrower for the deposit of several commercial loans, all of which were refinanced with the SBA loan. Since borrowed funds generally do not qualify as equity, the checks alone were not sufficient evidence of the principal’s equity injection. The OIG made two recommendations.