The Office of the Comptroller of the Currency (OCC) issued a bulletin to inform banks and examiners about sound risk management principles associated with engaging in the U.S. Small Business Administration (SBA) guaranteed lending programs. The primary risks associated with SBA lending are credit, operational, compliance, liquidity, price, and strategic. The bulletin notes that a bank's SBA lending activities, including purchasing investments backed by SBA-guaranteed loans, should be consistent with its overall business plans, strategies, risk appetite, and sound risk management. This bulletin applies to community banks engaged in SBA lending activities.
The Key SBA Lending Programs include the 7(a) loan program, which guarantees a portion of a loan made by a bank, and the certified development company (CDC)/504 loan program (commonly referred to as the 504 loan program), which can improve a bank’s senior secured lender position through subordinated permanent or takeout financing by a CDC. The following key risk management principles are set out in the bulletin:
- Strategic Planning. Banks specializing in SBA lending or secondary marketing or contemplating expanding into this area should develop a sound business strategy that addresses SBA lending, loan sales, and loan purchases, as applicable. A sound strategy outlines existing or planned activities, including how associated risks are managed and how planned lending, product growth, or acquisition activities are consistent with the bank’s risk appetite, defined business goals, portfolio objectives, infrastructure capacity, and strategic and capital plans.
- Policies and Processes. Effective SBA lending is supported by sound SBA lending policies and processes. The items and level of detail included should be commensurate with the nature and extent of the bank’s SBA lending activities. Appropriate policies should typically address standards for underwriting and documentation, credit administration, risk management of third parties involved in the bank’s SBA lending processes, and accounting and regulatory reporting.
- Personnel. A knowledgeable management team and experienced personnel with sufficient expertise, training, and familiarity with current SBA rules, regulations, policies, procedures, and guidance should support banks engaged in SBA lending. Appropriate compensation programs for lending personnel should be based on the overall risks and rewards of the bank’s SBA lending activities and not be solely tied to the volume of loan originations or sales.
- Control Systems. Prudent control systems include quality control, quality assurance, independent credit risk review, and internal or external audit. Reviews and audits conducted by the SBA do not substitute for a bank’s control systems. Robust liquidity and pipeline management reporting can help a bank control risks associated with potential SBA funding and execution challenges.
- Risk Rating SBA Loans. When risk rating an SBA loan, the unguaranteed exposure should be assessed in conjunction with the guaranteed exposure. Repayment capacity should be assessed relative to the entire SBA obligation.
- Credit Loss Allowance. Banks should maintain an appropriate methodology and balance for the credit loss allowance related to SBA loans held in the bank’s portfolio. The bank’s methodology should identify the differences in credit risk between the guaranteed and the unguaranteed portions of SBA loans, and the differences between the SBA’s conditional and unconditional guaranty, and accordingly establish an appropriate allowance.
- Concentration Risk Management. Concentration risk management practices should be commensurate with the bank’s SBA loan exposures.
- Stress Testing. Stress testing is an important part of a bank’s capital and strategic planning. Depending on the size (including concentrations) and complexity of a bank’s SBA exposure, it may be prudent for the bank to implement loan- and portfolio-level stress testing. A bank can implement risk-based stress testing at origination and at periodic intervals. For a bank with significant concentrations, concentration limits should be stressed and reassessed when there is a significant change in relevant risk factors.
- Regulatory Reporting. SBA loans, both the guaranteed and unguaranteed amounts, should be reported with other loans under the appropriate loan categories in Schedule RC-C of the Consolidated Reports of Condition and Income (call report).
- Capital Considerations. Banks should have adequate capital to support their overall SBA exposures, particularly the unguaranteed portions. The guaranteed portion of the SBA loan receives favorable regulatory capital treatments.
- Accounting for SBA Loan Sales and Assets. When a bank sells an SBA-guaranteed loan in whole or in part, the sale is subject to certain accounting standards regarding sales treatment, income recognition, and fair value measurement.
Keywords: Americas, US, Banking, SBA, Lending, Credit Risk, Reporting, Risk Management Principles, Stress Testing, Credit Loss Allowance, Concentration Risk, OCC
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