The SBA has made it a priority to improve quality control and scrutinize defaulted loans, especially early-defaulted loan for fraud, waste and abuse.
The Office of Inspector General ("OIG") has released several reports detailing areas of repeated patterns found in early-defaulted loans.
Loan agent and borrower fraud, eligibility, and use of proceeds are just some areas where material deficiencies have been found in early defaulting SBA loans.
Early defaulting loans are reviewed carefully for material deficiencies at the National Guaranty Purchase Center. Lenders should be aware of the most common reasons for SBA loan early-defaults and implement policies and controls to protect against those issues in their own SBA lending practice.
Loan Agent Fraud. If you are using loan agents, make sure you have a Lender Service Provider agreement in effect, approved by the SBA. Before you start working with a new loan agent, get references from other lenders to determine if the agent has a history of early defaulted loans. While almost all loan agents are ethical, OIG findings on early-defaulted loans found loan agent fraud to be a factor in many cases.
Issues to consider when working with loan agents in order to minimize fraud include: control of communications by the loan agent; whether a loan agent threatens to "shop" the loan elsewhere in an attempt to pressure the lender to close the loan; submission of a high number of "qualified" borrowers in a short period of time; difficult questions/issues are easily resolved (i.e., missing documents are quickly generated as the result of an inquiry or ledgers created to document a pre-existing debt); the loan agent wants to use specific appraisers or title companies; and whether the loan agent charges excessive fees.
Prudent lending practices when dealing with loan agents include tracking the loan agent's participation in the lender's portfolio to determine whether that individual is bringing in an unusually high number of early-defaulted loans or the loans have other material issues.
Borrower Fraud. Examples of borrower fraud include misrepresentation regarding the original purpose and use of refinanced debt; false equity injection, gift letters or affidavits, promissory notes and standby agreements (i.e. no intention of putting the obligation on standby), false financial statements; overvaluation of assets; failure to disclose outstanding debts; overstating income, failing to disclose true ownership of a business or common ownership between a seller and buyer; submitting altered tax returns; and misrepresentations regarding affiliate size.
OIG found many instances of fraud in Change in Ownership transactions. Lender due diligence must include obtaining copies of all relevant purchase documents. For example, in a stock redemption transaction, obtain a copy of the stock ledger and copies of all issued stocks pre and post closing. The stock certificates should be redeemed and retired, and not transferred or reissued to an individual. Selling shareholders should resign as an employee/officer/director of the company. Resolutions are also required showing the appointment of any new officers/directors.
Lenders are expected to comply with the equity injection verification requirements contained in SOP 50-10-5(E) Chapter 4 and SOP 50-51(C) Chapter 13. OIG investigations have repeatedly found that the cash injection was actually borrowed. Further, Lenders should verify gift money with at least two (2) months prior bank statements from the giftor. Lender should also obtain evidence of the transfer of the funds to the Borrower and an affidavit that no repayment is due to the giftor.
Fraud by loan officers and other lender employees. The SBA has recommended Lenders implement internal controls to both deter and detect suspicious lending activity, including: development of sufficient management oversight of loan approvals; policies (such as a Code of Conduct) to require business development officers and other lender personnel to disclose the involvement of brokers and loan agents in generating or packaging loans; limits on commissions and other internal inducement that incentivize loan officers to concentrate on loan volume rather than loan quality; internal review and auditing functions to analyze patterns of early defaulted loans or other material issues and the personnel involved; and policies to require a higher level of review on change of ownership transactions.
By originating and closing loans in accordance with the SOP, and using prudent lending standards applicable in any commercial transaction, a lender's risk of processing a fraudulent or early defaulting loan can be greatly reduced.
All instances of fraud should be reported to IG immediately. Contact the OIG hotline at 1-800-767-0385 orOITHotline@sba.gov.