On September 20, 2002, the OIG issued Audit Memorandum 2-31, Impact of Loan Splitting on Borrowers and the SBA. The purpose of the memorandum was to alert the SBA to issues related to a practice that the OIG refers to as "loan splitting." In this case, the loan splitting occurred when a single loan was split into two loans to the same borrower for the benefit of the lender. The objective of this review was to determine if the split loans were originated in accordance with program regulations and to assess the impact of split loans on the borrowers and the Agency.
The loans were split so that one loan could be used to acquire or refinance real estate and the second loan would finance the construction of a new building or improvements to existing structures located on the acquired real estate. According to the lender, this was done so the acquisition portion of a borrower financing could be sold as a separate loan on the secondary market sooner than if the two loans were combined. Under SBA regulations, loans cannot not be sold until fully disbursed. Improvements loans—usually disbursed incrementally over time—generally take longer to sell than do acquisition loans, which are fully disbursed at settlement.
The OIG examined 12 loans totaling $ 4.3 million to six borrowers that received two loans each. All 12 loans had maturities of 25 years and were approved during FY 2001. The loans were selected from a list of approximately 858 section 7(a) loans that were approved by a single PLP lender mostly during the period of FY 1996 to FY 2002.
The OIG found that loan splitting, as described herein, does not appear to violate program regulations. There are, however, some negative aspects to this practice that impact both the borrowers and the Agency. Also, two of the loans we reviewed did not conform to program term limits. Specifically, the OIG found that loan splitting increased closing costs. The closing costs charged to the borrowers that received split loans increased as much as $200. This was due to the filing fees associated with the additional set of documents necessary for the second real estate loan, such as deeds, certifications, and assignments. Due to a lack of documentation in the lender's loan files, the OIG was not able to determine if there were any additional attorneys' fees for the preparation of documents for the second loan, which had to be tied into and subordinated to the first loan.
The OIG also found that loan splitting inflated loan production performance data. The reported number and average size of 7(a) loans approved during a given period may be misleading. The method used by the SBA to calculate loan production and performance measures did not take into consideration the number of loans that split into multiple loans. This resulted in an inflated number of reported approved 7(a) loans and a reduction in the average size of the approved loans. Similarly affected by this method of calculation are the number of loans approved for women, minorities, and veterans.
Lastly, the OIG found that maturity limits were exceeded in two of the twelve split loans examined. Pursuant to the Federal Code of Regulations (CFR), the term of a loan shall be ten years or less, unless it is used to finance real estate or equipment with a useful life exceeding ten years. A maximum of 25 years is allowed for loans used to acquire or improve real property. Further, the SOPs provide that improvement expenses qualify for a 25-year maturity period only if they cost one-third or more of the purchase price or current appraised value of the real estate.
The two split loans the OIG examined were used to finance improvements to the buildings that were purchased with acquisition loans. Both improvement loans were given the same 25-year maturity period as the acquisition loans, even though the amounts of the improvement loans were far less then 33 percent of the purchase price of the buildings. In one case, the acquisition loan used to purchase the building was $1,164,000, and the improvement loan was $55,000, or 4.7 percent of the building purchase price. In the other case, the acquisition loan was $495,000 and the improvement loan was $76,500, or 15.4 percent. Consequently, the improvement loans did not meet the 33 percent requirement to qualify for a 25-year maturity period and should have been limited to 10 years or less, depending on the expected economic life of the improvement.