Presented by Kimberly Rayer Esq Lyndsay E Rowland

Presented by: Kimberly Rayer, Esq. Lyndsay E. Rowland, Esq. Workout and Liquidation of SBA 7(a) Loans

AGENDA p Workout and Liquidation p Guaranty Purchase Process § Express Loans § 7(a)

Policy Goal p Balance SBA’s interest in: n Helping small businesses to succeed n Minimizing losses to the Agency p SOP 50 57 2 – December 1, 2015 n 7 a Loan Servicing and Liquidation 3 © 2017, Starfield & Smith, P. C.

Key Definitions Loan Characterization p. Early Default an event of default that occurred either within 18 months of the initial disbursement of the loan (or within 18 months of the final disbursement of the loan if the final disbursement occurred more than six months after the initial disbursement), unless the Borrower cured the default and made the scheduled loan payments for 12 consecutive months following the 18 month period: n Failure to make a scheduled loan payment; n Funding a scheduled loan payment from the sale of collateral rather than from business operations; n Deferment of more than three consecutive scheduled full payments; or n Any other event of default that required the loan to be classified in liquidation status, e. g. , bankruptcy. p. Seasoned Loan or a loan that is “Seasoned” means a loan that is not an Early Default Loan 4 © 2017, Starfield & Smith, P. C.

Key Definitions SBA Concepts p. Purchase, whether capitalized or not, when used in conjunction with SBA's 7(a) loan guaranty ("guaranty purchase") refers to SBA's purchase of the guaranteed portion of a 7(a) Loan. p. Preference means an arrangement not pre-approved by SBA that gives a 7(a) Lender a preferred position compared to SBA relating to the making, servicing, or liquidation of an SBA loan. (13 C. F. R. § 120. 10) E. g. , a Lender would receive a Preference if it released the collateral for an SBA loan in order to use it as security for a non-SBA loan to the same Borrower. 5 © 2017, Starfield & Smith, P. C.

Liquidation Actions p p p p Liquidation Status Site Visits Workouts Real Property Liquidation Personal Property Liquidation Acquired Collateral Offer In Compromise Litigation Expenses Guaranty Purchase Denial of Liability Inspector General Referrals Charge-off and Wrap-up 6 © 2017, Starfield & Smith, P. C.

Liquidation Status p When? Lender must classify in liquidation when Note is accelerated p Lenders may accelerate Note when: n Lenders with non-SBA portfolios: p Refer to policy for similarly sized non-SBA loans p Guaranty purchase only if >60 days past due n Lenders without non-SBA portfolios p Should accelerate if default and no realistic likelihood of cure § Business closure, >60 days past due, etc. p Upon acceleration and transfer to liquidation status, lender must repurchase from secondary (or demand SBA repurchase) 7 © 2017, Starfield & Smith, P. C.

Liquidation Status p Demand Letter – all obligors (proof of delivery) n Upon Acceleration n Immediate Payment n Active duty military – comply with Servicemember’s Civil Relief Act (SCRA) (50 57 p. 80) p Locate Obligors and Collateral p Liquidation Plan (should, not must) n Exception for CLP loans – Mandatory p Remove from Liquidation Status n Return to Regular Servicing (after 3 timely payments) n PIF n Charge off after approval of Wrap-up 8 © 2017, Starfield & Smith, P. C.

Site Visits p Pre-default: follow conventional loan requirements p Post-default: required if recoverable value would constitute a Material Loss ($5 k$10 k) n Payment default: w/in 60 days of default n Other defaults: w/in 15 days of occurrence of adverse event p“or sooner if the collateral could be removed, lost or dissipated” n Be reasonably prompt. 9 © 2017, Starfield & Smith, P. C.

Workouts p Sold loans should be repurchased prior to workout p Feasibility Test. Is Borrower: 1. 2. 3. 4. Competent? (has skills to turn around) Cooperative? Acting in Good Faith? Financially & operationally “viable” p Timing – ASAP, within 60 days (of? ) 10 © 2017, Starfield & Smith, P. C.

Workouts p Required Financial Info. n Financial statements (sworn) p. Current p. Year-end (most recent) p. Consolidated (if affiliates) n FTR’s (2 years) p. Business p. Guarantors p If financial info. is not provided, a workout should not be pursued! 11 © 2017, Starfield & Smith, P. C.

Workouts p Consideration: 1. 2. 3. 4. 5. Correct document errors Waive defenses Release Lender Liability (and all other) claims Provide additional collateral; and Consent to speedy liquidation if workout fails p Enforceable? 12 © 2017, Starfield & Smith, P. C.

Deferments p “temporary solution to a temporary problem” p Not appropriate if loan is > 60 days past due (liquidation status) p Deferments may not exceed 6 consecutive months (or 20% of principal, whichever is less) at a time – additional deferments require justification p Secondary market – one time, 3 month deferment w/o investor approval 13 © 2017, Starfield & Smith, P. C.

Assumption, Assignment or Sale p Assumption n n Eligibility required, unless workout/liquidation No release – collateral or obligors Due on sale or death Seller may not retain CRE p Assignment n Sale only to another participating lender n SBA approval p Sale of loan in liquidation status n n Only after guaranty purchase approval No sale to Borrower – other Associates require SBA approval No compromise of principal balance Price bears reasonable relationship to Recoverable Value 14 © 2017, Starfield & Smith, P. C.

Real Property Liquidation p Required if Recoverable Value > $10 k n Unless compelling documented reason for not doing so p Due diligence n Searches, military status, site visit, loan documents, title, sr. liens, etc. n Consider: disposition of Sr. liens, liquidation strategy, leases, hazard insurance status, etc. n Appraisal n Environmental – Commercial property n Need to collect deficiency n Cost/benefit analysis 15 © 2017, Starfield & Smith, P. C.

Real Property Liquidation p Liquidation Methods: n Release for consideration n Voluntary sale by Obligor p Maintain control over sale, ensure reasonable sale price; control proceeds of sale n Deed in lieu p Consider state specific effects on deficiency collection and foreclosure of subordinate lienholders p Obligors must confirm amount to be applied to loan n Rent collection p Letter to tenant or Receiver n Receiver p Requires SBA approval p Litigation Plan p “Exceptional Circumstances” n Short Sale – at least = Recoverable Value and no release of Obligor 16 © 2017, Starfield & Smith, P. C.

Real Property Liquidation p There are two types of actions to foreclosure mortgages depending on the state n Judicial – requiring a lawsuit to obtain a judgment in foreclosure n Non-Judicial – generally requires an auction through a third party but not a filed lawsuit to obtain judgment 17 © 2017, Starfield & Smith, P. C.

Personal Property Liquidation p Required if Recoverable Value > $5 k n Unless compelling documented reason for not doing so p Due diligence n Searches, taxes, military status, site visit, loan documents, sr. liens, etc. n Collateral type: titled vehicles, airplanes, vessels n Consider: disposition of Sr. liens, liquidation strategy, landlords, hazard insurance status, etc. n Valuation n Environmental issues – hazardous materials on premises? n Cost/benefit analysis 18 © 2017, Starfield & Smith, P. C.

Personal Property Liquidation p Liquidation Methods: n Release for consideration n Voluntary sale by Obligor n Judicial Foreclosure n Setoff against deposit account (possession or control) n UCC Sale p Private Sale p Public Sale p Requirements: possession (absent breach of the peace”); reasonable notice (10 days) to all obligors and junior lienholders p Bill of Sale 19 © 2017, Starfield & Smith, P. C.

Liquidation Status Reports p Lenders are responsible for keeping SBA informed of liquidation activities after purchase n status report 15 days after SBA’s purchase n status reports at least every six months after purchase 20

Offer In Compromise p General Requirements: n Liquidation status n No Bankruptcy n Full amount cannot be recovered n No fraud, misrepresentation, or financial misconduct n Amount offered bears “reasonable relationship” to Recoverable Value from enforced collection 21 © 2017, Starfield & Smith, P. C.

Offer In Compromise p Required documents (unless basis is litigative risk): n SBA Form 1150 (written offer) p Include special circumstances n Current financial statement of Obligor making offer, plus last YE financial statements and last 2 FTR’s n If there are Affiliates, consolidated financials are required n Credit report n Tax transcripts n Any other independent financial information 22 © 2017, Starfield & Smith, P. C.

Offer In Compromise p Payment Terms: n Cash is preferred – payment within 60 days of SBA approval n Term compromise p Maximize recovery p Written agreement p If default under OIC, full amount under original note due in full p Remedies (confession of judgment, delivery of deed/bill of sale, etc. ) n Mutual release upon full payment n Apply amounts received to principal balance 23 © 2017, Starfield & Smith, P. C.

Litigation p Necessary, reasonable and customary p Cost effective n Due diligence n If not cost effective, refer to treasury p Legal Counsel requirements: n Licensed in state n Expertise in collection & bankruptcy n Adequate malpractice insurance n No conflict of interest 24 © 2017, Starfield & Smith, P. C.

Litigation p Litigation Plans n SBA approval required for: p. Non-routine litigation p. Legal fees > $10, 000 (15% variance) p. SBA should respond within 15 days; however failure to respond ≠ consent p Provide SBA copies of all documents for non-routine litigation 25 © 2017, Starfield & Smith, P. C.

Prudent Liquidation Deadline p Either 24 months of purchase by SBA or 24 months after the effective date of this SOP for loans where lenders are actively liquidating, whichever is longer, p Unless an extension is approved 26

Charge-off and Wrap-up p Appropriate when: n All liquidation activities are complete n Cost of further collection will exceed recovery n Balance is otherwise uncollectible n Wrap-up to be submitted within 90 days of completion of liquidation 27 © 2017, Starfield & Smith, P. C.

Charge-off and Wrap-up p Wrap-up Report contents: n n n Loan info. Obligor status – still liable? Demand Letters for each Obligor Narrative of efforts to locate missing Obligors Estimate of potential recovery from each Obligor Status & disposition of collateral Site visit Expenses Recoveries Recommendation 28 © 2017, Starfield & Smith, P. C.

Charge-off and Wrap-up p Treasury Referral n Mandatory, except for Obligors that received discharge in Bankruptcy n Recoveries shared with Lender on a pro-rata basis p 1099 for written-off or uncollectible debt p Credit bureau reporting 29 © 2017, Starfield & Smith, P. C.

The SBA Guaranty Purchase p Four Pillars of Guaranty Purchase p Guaranty Purchase Process

The Four “Pillars” of a Guaranty Purchase Review p Origination: Determine that the loan was originated in accordance with regulations and Standard Operating Procedures in place at the time of origination. Eligibility is key. p Closing: Evaluate whether the loan was closed in accordance with the Loan Authorization. Collateral is key. p Servicing: Evaluate whether the servicing of the loan was in accordance with the loan documents, regulations, and prudent lending practices – and whether those actions caused harm to the Agency. Modifications and releases. p Liquidation: Evaluate whether the liquidation and collection on the defaulted loan was prudent and followed program guidelines. Site visits, environmental reports, and appraisals. 31 © 2017 Starfield & Smith, P. C.

Lender’s Burden of Proof: MATERIALITY n NGPC focuses on “material” deficiencies that cause a significant loss or harm to SBA, or are a matter of program integrity n “Was the deficiency the cause of the loss” (does not apply to eligibility analysis – always “material”) n Burden of Proof is on the LENDER, not SBA p “Guilty until proven innocent” p No assumptions of compliance will be made by SBA p Prove that deficiency did not cause the loss or the failure of the business 32

7(a) Guaranty Purchase Process Flow 1 Intake 2 Screening If a purchase package is complete it moves from step 1 through step 6 with no stops. If there are questions or missing documents the package is sent to Customer Service to request additional information from the lender. 3 Legal 1 4 5 6 Financial Review Legal 2 Approver Customer Service An Legal 2 review is only required when the loan is recommended for charge off at the time of purchase, or if a repair or denial issue has been raised during the Legal 1 or Financial Review. 33 © 2017, Starfield & Smith, P. C.

When do you submit your 7(a) Loan Guaranty Package? p After the loan is fully liquidated p Within 45 calendar days after purchase of the guaranty portion of the loan by the SBA from the secondary market p No later than 180 days after maturity date of the loan, or 180 days after the date that lender completes liquidation on a matured loan [whichever is later] 34

7(a) Loan 10 Tab Structure § The cover sheet of the Tabs explains the process and outlines the categories to be addressed behind each tab. § The documents are arranged in logical groups to facilitate package submission. § The Tabs are available on the SBA website as a fill-able PDF with links to all mandatory and suggested forms and all documents needed in the purchase review process are located at www. sba. gov/banking. Search for: Regular 7(a) Guaranty Purchase Package Tabs 35 © 2017, Starfield & Smith, P. C.

How to Submit a “Perfect” 10 Tab Purchase Package p Start at origination! Organize and build your loan files following the mandatory 10 -Tab System used to organize purchase requests. Audit yourself – are all forms & documentation in order? p Thoroughly follow instructions and provide complete information to speed up the purchase request process. p ALWAYS go the SBA website to get up-to-date instructions and forms! www. sba. gov/banking p Consult with experienced professionals such as SBA attorneys and SBA consultants 36

Possible Outcomes of Guaranty Purchase Review p Purchase: Purchase request is complete, there is no harm to the Agency, and meets all criteria for honoring the payment in full. A decision to fund is reached within the 45 -day Brand Promise. p Repair: A decision is reached to honor the guaranty, but not in the full amount, due to a material deficiency during origination, closing, servicing, and/or liquidation. p Denial: A decision is reached to deny the guaranty in full. This must have headquarter’s concurrence. p Cancel/Terminate: Based on the facts of the case, the lender chooses to cancel or terminate the guaranty. p Withdrawal: Lender needs more time to collect documents and provide additional information, therefore withdraws the request. The guaranty is still in full effect and the purchase request can be made anytime thereafter. 37 © 2017, Starfield & Smith, P. C.

PRACTICE TIPS p Provide a complete package with executed tabs to ensure quick processing. Be sure to include all required documents and answer all questions on tabs. p Inform NGPC proactively of missing documents and deficiencies to avoid screen-outs that delay processing. p Audit your loan file at origination using the 10 -Tab system to ensure that all documents are present at origination. Excellent internal control to resolve issues prior to the deterioration of your relationship with your borrower. p Tell the Story. Provide an optional executive summary, cover sheet or letter that makes it easier for the SBA Purchase Center officer to get oriented to the “guts” of the deal, to focus on key issues and mitigate any key concerns that may be present. 38 © 2017, , Starfield & Smith, P. C.

Top Reasons for Repairs and p Lien and Collateral Issues that Result in Missed Recoveries Denials (Generally a Repair) n Failure to obtain required lien position n Failure to properly perfect security interest n Failure to fully collateralize loan at origination when additional collateral was available p Unauthorized Use of Proceeds n Proceeds disbursed for purpose(s) inconsistent with the loan authorization or subsequent modifications without a business justification. (Could be a denial if early default and improper use of proceeds caused the failure of the business) n Same lender Non-SBA loan paid with PLP loan proceeds (preference) © 2017, Starfield & Smith, P. C.

Top Reasons for Repairs and p. Denials Liquidation Deficiencies (Generally a Repair unless harm is the full value of the outstanding balance) n Failure to conduct site visit which resulted in missed recoveries n Improper safeguarding or disposition of collateral which resulted in missed recoveries n Misapplication of recoveries to lender’s loan when SBA-guaranteed loan has lien priority p Undocumented Servicing Actions (Generally a Repair) n Liens not properly renewed during servicing on worthwhile collateral n Release or subordination of collateral without documented business justification n Allowing hazard insurance to lapse on major collateral and collateral was subsequently destroyed n Failure to maintain life insurance on principal and principal subsequently dies 40 © 2017, Starfield & Smith, P. C.

Top Reasons for Repairs and Denials p Early Defaults (Denial if determined to be reason for business failure) n Missing or unsupported verification of required equity injection (includes verification of source in some cases) n Missing or unsupported documentation of verification of borrower financial information with IRS when financial information was relied on in lender’s credit analysis p SBA Loan Eligibility (Denial) n n n Ineligible franchise Ineligible loan purpose Ineligible loan recipient (loan to an associate of lender) Conflict of interest Unauthorized PLP Processing Exceeding program limits 41 © 2017, , Starfield & Smith, P. C.

Questions ? ? ? 42 © 2017, Starfield & Smith, P. C.

Thank you! p Kimberly A. Rayer, Esq. n krayer@starfieldsmith. com p Lyndsay E. Rowland, Esq. n lrowland@starfieldsmith. com 1300 Virginia Drive Suite 325 Ft. Washington, PA 19034 P: 215 -542 -7070 F: 215 -534 -9023 2600 Maitland Center Parkway, Suite 330 Maitland, FL 32751 P: (407) 667 -8811 F: (407) 667 -0020 43 © 2017, Starfield & Smith, P. C.