Sba sop 51 00 On-Site Lender Reviews/Examinations Office of Lender Oversight
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8. Liquidity Examination Componenta. IntroductionSufficiently liquid funds are necessary to meet all obligations and to increase the SBA Supervised Lender’s assets. Liquidity is also necessary to compensate for any decreases in capital. For example, the SBA Supervised Lender would need sufficiently liquid funds to pay any dividends declared by the BOD. Sufficient liquidity ensures that the SBA Supervised Lender will be more likely to sustain unexpected demands for funds. The primary sources of liquidity for an SBA Supervised Lender are loan sales, lines of credit with commercial banks or alternative financiers, and cash. A brief description of each will follow. Loan Sales The SBA Supervised Lenders generally make only loans carrying the SBA guarantees. Most have a practice of securitizing the guaranteed portions of the loans and selling the resulting security in the capital markets. Some of the larger SBA Supervised Lenders even package the unguaranteed portions of the loans, securitize them, and sell them in the capital markets. These sales provide liquid funds for the SBA Supervised Lenders. The SBA Supervised Lender must also meet currency rate requirements set forth in 13 CFR 12 §120.425(c), to maintain its PLP delegated lender status. Lines of Credit Many of the SBA Supervised Lenders have established lines of credit with commercial banks in their territory. The SBA Supervised Lenders can draw on the line under agreed upon conditions. The SBA Supervised Lenders pay a certain rate and, often, a user fee for this ability. Typically, these lines of credit must be renewed on an annual basis. In addition, all assets owned by the SBA Supervised Lender usually secure the lines of credit. Cash Cash comes into the corporation due to cash flow from various sources. Examples include the sale of loans, payments from borrowers, and any payment for servicing fees the SBA Supervised Lender might receive. Of course raising additional capital, whether it be equity or debt, would provide additional funds. Given the lengthy process to complete a capital sale, raising capital is not considered a typical primary or secondary source of liquidity. b. Examination CriteriaAvailability of lines of credit. For many SBA Supervised Lenders, lines of credit are very important sources of funds and, thus, liquidity. Because these lines are collateralized, the institutions offering these lines maintain an awareness of their borrowers’ financial conditions (the SBA Supervised Lender’s financial condition). If an SBA Supervised Lender’s financial condition deteriorates, its line of credit may become more expensive at the next renewal. In the extreme situation, the bank granting the line of credit may terminate the line at the first opportunity. This would be problematic for an SBA Supervised Lender with no other sources of liquidity, especially if no other bank wanted to transact business. Agreements between SBA Supervised Lender and creditor bank(s). Depending on the SBA Supervised Lender’s reliance on borrowed funds supporting the operation, an increase in the cost of the line may restrict an expected dividend or curtail lending activity. Lenders need inexpensive sources of liquidity. Examiners must evaluate the agreement between the SBA Supervised Lender and its creditor bank to determine the cost of the line, and any unusual performance criteria with which the SBA Supervised Lender may struggle. Examiners should be particularly sensitive to any communication from the bank that expresses dissatisfaction with the SBA Supervised Lenders performance. Projection of long-term liquidity demands. Examiners should also be alert to any unusual or unexpected demands, real or potential, on liquidity. One potential demand is pending litigation. Another example is a parent’s request for a distribution from its subsidiaries. Any contingent liabilities such as commitments and unused lines of credit must also be considered as they represent potential exposure to the SBA Supervised Lender. In cases where there are potential demands, examiners must assess the likelihood that a draw on liquidity will occur. Forecast of short-term liquidity demands. The ordinary demands on liquidity for an SBA Supervised Lender include funding loan commitments, paying dividends or distributions, and servicing debt. The examiner must estimate the near term outflows to determine if there are sufficient short-term sources. Further matters for the examiner’s consideration involve operating expenses. Operating income routinely covers these expenses. However, any SBA Supervised Lender that becomes unprofitable must rely on liquidity to pay expenses. It is important to note that the securitizations discussed above are sold on a non-recourse basis. Therefore, there is no potential liquidity threat once the unguaranteed portions are sold. Examiners do have to be wary of the satisfaction of the buyers of the subordinated traunches containing unguaranteed loans. If they are dissatisfied with their investment because too many of the loans default, they may try to argue that the loans were poorly serviced by the SBA Supervised Lender. However, even if they claim no improper action, they are still dissatisfied with their investment. This could be harmful if the markets reflect that one or more SBA Supervised Lenders make poor credit decisions, sell the loans, and losses occur. Examiners should evaluate whether management understands the importance of maintaining adequate liquidity. It is also important to assess whether management properly manages the maturity relationship between assets and liabilities to ensure effective cash flow management. The alternative to building liquidity can be costly. However, excess liquidity, carrying large amounts of cash earning little profit, may cause other problems. Some of the SBA Supervised Lenders are subsidiaries of large, well-known companies. As a result, there is some thought that these SBA Supervised Lenders have an unlimited source of liquidity. Correspondence between the two parties should provide some insight. If this is a solid conclusion, the scope of the evaluation of liquidity should be reduced. c. Examination ObjectivesThe objectives of the Liquidity component section are:
d. Examination ProceduresThe following examination procedures are provided to facilitate the examination of liquidity. Consistent with risk-based examination principles, examiners should add, delete, or modify these procedures as circumstances warrant.
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