LOAN FUND POLICIES
CONTENTS: Page:
Introduction..........................................................2
Loan Products .....................................................2
Portfolio Structure ...............................................2
Eligibility...............................................................2
Use of Loan Proceeds .........................................3
Application Requirements ....................................3
Matching Requirements .......................................3
Loan Terms ........................................................3
Diversification of Risk .........................................3
Diversification by Type, Sector
or Geographic Location ......................................3
Interest Rates .....................................................4
Loan Fees............................................................4
Debt Refinancing .................................................4
Screening and Assessment / Loan
Approval Process...........................................4
Staff Loan Committee ..........................................5
Board Loan Committee ........................................5
Loan Restrictions for Customers on
Parole or Probation .......................................5
Loan Loss Reserve ..............................................5
Delinquency and Default ......................................5
Loan Charge-Offs ...............................................6
Collections...........................................................6
Non-Accrual and Loan Restructuring ...................6
Environmental Policy ........................................... 6
Fund Termination .................................................7
Attachments
A: Underwriting Guidelines .............................8
B: Risk Management ....................................10
C: Loan Rating Classification ........................11
D: Loan Documentation ...............................12
Loan Policy Addendum .....................................13
Introduction The purpose of this document is to set forth the policies and procedures for the lending, risk management, monitoring, documenting and establishing credit decision-making process for the Southeastern Minnesota Microenterprise Fund. Loan Products The Southeastern Minnesota Microenterprise Fund is designed to be flexible and responsive to a variety of business situations. Our loan products include the following:
Portfolio Structure · Internally, the portfolio will be managed as the: Microenterprise Loan Fund (MEF)
Eligibility The applicant needs to be within the boundaries of a currently SEMDC contracted community or county or within the boundaries of a founding member community or service territory.
Use of Loan Proceeds Eligible uses of loan dollars include the following: Ineligible uses of loan dollars, include the following · debt refinancing · equipment relocation within same structure · routine maintenance · illegal activities · businesses that derive the majority of their income from restaurant or liquor sales
Application Requirements An application for a loan from the Southeastern MN Microenterprise Fund, at minimum, includes the following:
Matching Requirements The loan fund provides financing where other sources aren’t available and can finance all (100%) or part of a financial package. Equity requirements will be negotiated on a case-by-case basis. Sufficient collateral, including personal guarantees, will be required on all loans; however, Microloans will not be denied specifically for lack of collateral. Collateral guidelines are attached as an addendum. Loan Terms The term of each loan ranges from 60 days to 6 years for loans under $35,000. A longer amortization can be used in conjunction with a balloon payment, provided that the term of the loan does not exceed 6 years. Diversification of Risk The total amount of loans outstanding to any one or group of borrowers at a time will not exceed $35,000 for a Microenterprise. For a small business, the total amount of loans outstanding will not exceed 10% of the fund’s total small business loan capital or $35,000 which ever is greater. Any deviation from this policy requires approval by the Board of Directors. Diversification by Type, Race & Ethnicity, Sector or Geographic Location The Loan Fund Manager monitors the portfolio for diversification among customer types, race and ethnicity, business sectors, and geographic location of member communities, counties and their territories to minimize concentration. Interest Rates The Southeastern MN Microenterprise Fund loan interest rate Loan Fees The loan recipient will be responsible for a $100 origination fee, plus the actual cost of searches, credit reports, filling and legal fees. In no circumstance will these fees exceed $350. Screening and Assessment / Loan Approval Process The process for loan assessment and review begins when the entrepreneur has completed their business plan that is appropriate for the size and complexity of the business. Usually one of our Business Consultants has worked with them during the development process. If not, the Business Consultant or Loan Fund Manager reviews the plan and tests the entrepreneur’s understanding of the plan and the business. This test often includes a line of questioning seeking detailed explanations from the prospective borrower about the market or cash flow projections beyond what is stated in the plan. Through this process, strengths and weakness will be determined. Additional technical assistance will be given to borrower to determine ways to address any weak points in the plan. The loan approval process varies depending upon the fund’s total exposure to this client as a result of this loan. If the Business Consultant believes that the borrower’s business plan and loan request are strong, the loan request continues onto the following loan approval process. 1. The potential borrower meets with the Business Consultant to review the plan. 2. The loan request undergoes a technical/due diligence review. 3. The loan request proceeds to the Staff Loan Committee, which is composed of the CEO/President, SEMDC Board President, and Business Consultant. 4. If recommended for approval by the Staff Loan Committee, the loan request proceeds to the Board Loan Committee. They meet as needed. 5. A copy of the Loan Request Summary will be submitted to the Board of Directors. 6. The Board of Directors approves, rejects or returns the application to the Staff Loan Committee. The Board of Directors will review approval authorization limits quarterly or as needed based on fund performance. Staff Loan Committee The Loan Committee will be composed of the following Southeastern Minnesota Development Corporation staff: The Staff Loan Committee meetings will be held as needed. The Staff Loan Committee will also function as the committee to determine status and process of a problem loan. Board Loan Committee The Board Loan Committee is composed of the five executive committee board members of the Southeastern Minnesota Development Corporation. The Board Loan Committee meets on an as needed basis and usually meets through a scheduled telephone conference or other appropriate means. Loan Restrictions for Customers on Parole or Probation The Southeastern Minnesota Microenterprise Fund will not loan money to people who are presently on parole or probation. After the customer has successfully completed their parole or probation, there will be no distinction concerning this matter. Loan Loss Reserve The Southeastern Minnesota Microenterprise Fund maintains a loan loss reserve equal to at least 15% of the principal balance of outstanding loans booked in Microenterprise Loan portfolio. Loans booked into the Enterprise Loan Fund will be reserved at a level corresponding to the level of risk as depicted by the loan risk-rating schedule in Attachment C. Delinquency and Default Delinquency for reporting purposes is calculated after one payment cycle of the loan period, i.e. 30 days for a monthly payment, 15 days for a semi-monthly payment period. The CEO/President will generate a reminder call within three (3) days of a missed payment. A default letter is sent to a borrower when the debt maintains a delinquent status and the borrower fails to perform as promised in a delinquency work out and fails to communicate with the lender. A loan is considered in default if the entire principal balance is unpaid ten (10) days after written default notice is sent to the Borrower. Loan Charge-Offs The Board of Directors, at their quarterly meeting, will review the loan status of loans in delinquency and default. They decide which, if any, loans will be written off. Collections Collections are the last source of repayment and will begin immediately when a loan is in default. Every reasonable effort will be taken to recover the money owed by the borrower to the fund. Collections are pursued in accordance with the following guidelines, which have been established by the Board of Directors. 1. The CEO/President will recover collateral from the borrower that was used to secure the loan and arrange for its sale. 2. Judgments are filed against the borrower for the balance of the principal owed after sale of collateral. Where possible, judgments are filed through conciliation court. 3. The CEO/President tracks defaulted loans and seeks opportunities for repayment. For example, we are frequently able to arrange payment plans with the business owner. The CEO/President reports quarterly to the Board of Directors regarding the status. Loan Loss Reserve
The Southeastern Minnesota Microenterprise Fund maintains a loan loss reserve equal to at least 15% of the principal balance of outstanding loans booked in Microenterprise Loan portfolio. Loans booked into the Enterprise Loan Fund will be reserved at a level corresponding to the level of risk as depicted by the loan risk-rating schedule in Attachment C.
Delinquency and Default
Delinquency for reporting purposes is calculated after one payment cycle of the loan period, i.e. 30 days for a monthly payment, 15 days for a semi-monthly payment period.
The CEO/President will generate a reminder call within three (3) days of a missed payment.
A default letter is sent to a borrower when the debt maintains a delinquent status and the borrower fails to perform as promised in a delinquency work out and fails to communicate with the lender. A loan is considered in default if the entire principal balance is unpaid ten (10) days after written default notice is sent to the Borrower.
Loan Charge-Offs
The Board of Directors, at their quarterly meeting, will review the loan status of loans in delinquency and default. They decide which, if any, loans will be written off. Collections
Collections are the last source of repayment and will begin immediately when a loan is in default. Every reasonable effort will be taken to recover the money owed by the borrower to the fund. Collections are pursued in accordance with the following guidelines, which have been established by the Board of Directors.
1. The CEO/President will recover collateral from the borrower that was used to secure the loan and arrange for its sale.
2. Judgments are filed against the borrower for the balance of the principal owed after sale of collateral. Where possible, judgments are filed through conciliation court.
3. The CEO/President tracks defaulted loans and seeks opportunities for repayment. For example, we are frequently able to arrange payment plans with the business owner. The CEO/President reports quarterly to the Board of Directors regarding the status.
Non-Accrual and Loan Restructuring While we have not developed formal policies for putting loans on non-accrual or loan restructuring, the following principles will be applied to each instance where action is required. Each loan will be dealt with on a case-by-case basis, because the individual’s situations vary significantly. Loans may require an inspection or environmental audit especially if the property is to be mortgaged.
Environmental Policy Most loans that involve real estate as collateral will generally necessitate that the staff ask the borrower to answer the questions on an environmental questionnaire. If the potential for the borrower to incur environmental liability exists in any form, the possible risk to Southeastern Minnesota Microenterprise Fund will be weighed against the expected benefits and a decision made by the Board of Directors whether to make the loan. The environmental questionnaire will provide an indication of what step(s) should be taken next. The questionnaire will be a standard lender’s environmental questionnaire format. If the questionnaire raises any doubts a Phase 1 audit by an independent inspector will be ordered prior to loan approval or disapproval. In the event of contamination, the Southeastern Minnesota Microenterprise Fund may:
Fund Termination
In the event the Southeastern Minnesota Microenterprise Fund ceases operation, the loan fund balance will be divided among the fund contributors. A prorated share of the balance, based on initial investment, will be distributed to each contributor.
Attachment A:
Underwriting Guidelines
Southeastern Minnesota Microenterprise Fund
1. The prospective borrower meets eligibility requirements.
2. The business is feasible. It has access to the market, money and management resources it needs to achieve its business plan goals.
3. The business is viable. It’s products or services have the potential of a long-term connection to the marketplace.
4. The business plan identifies the need for financing and demonstrates the ability of the business to serve the debt.
5. The staff of the business has demonstrated they have the CAPABLITY of doing the work of the business based on prior experience and/or education.
6. The business plan demonstrates that the business has the CAPACITY with this financing to achieve the projections.
7. The business owner has demonstrated CHARACTER, i.e. having the business personality to function comfortably and effectively in their marketplace.
8. The business/business owner, through historical and projected performance is demonstrating a COMMITMENT to a long-term market relationship.
9. The business owner/business has a demonstrated performance of debt service as an indication of CREDIT WORTHINESS. A bad credit history is not a reason to deny a loan, unless the prospective borrower has not taken steps or is unwilling to repair their past credit issue.
10. The business/business owner has tangible assets that can be pledged as COLLATERAL against this loan. We will consider collateral relationships that are appropriate for the risk. A loan will not be denied because of lack of collateral, however, the personal and business collateral that is available must be pledged as a sign of commitment. The business owners’ capability, character, commitment and creditworthiness is also collateral. As a rule of thumb, the financial risk associated with the collateral can not exceed $5,000.
11. The business owner/business has developed a CONTINGENCY plan to repay the loan in case the market does not produce sales as projected, cash flow is not sufficient to serve debt, or the business fails. Contingency plans are described in the business plan.
Requests are reviewed utilizing the above with emphasis on the following:
1. Management and Organization. This is the key to the success of any business. A thorough analysis of the management strengths and weaknesses will be conducted through personal visits and community contacts. A plan to address weaknesses must be in place.
2. Market Factors. The market analysis will include customer identification, demand for product/services, general economic conditions, analysis of competition, overall market strategy and unique market conditions. The Management must be able to communicate a thorough understanding of the marketplace.
3. Credit Factors. Most importantly, the ability to repay debt. A minimum coverage ratio of 1:1 will be required. A cash flow analysis of historical cash flows will show whether the business has the ability to repay from existing operations or whether the loan will be repaid from cash flow of increased business. Other credit factors to be analyzed will include: Equity. Debt/equity should be no higher that 5 or 6:1 for existing businesses and 4 or 5:1 for start-ups. The breakeven analysis must depict financial feasibility through sales volume. Ratio analysis, (coverage, leverage, etc.), financial trends, and personal credit reports will all be utilized in the credit underwriting process.
4. Collateral. The value (cost and liquidation) of all collateral will be determined as well as the quality and the secondary markets that exist. Collateral can consist of real estate, accounts receivable, equipment and other tangible or intangible assets of value. Collateral distinctions will begin at a loan of approximately $5,000 and the Southeastern Minnesota Microenterprise Fund will not maintain a financial collateral risk of greater than $5,000 on any size loan. As a “Rule of Thumb” collateral, from a financial recovery perspective, will be valued at (based on fair market value):
Land & Building: 80%
Equipment: 50 - 80%
Inventory & Receivables: 25 - 50%
5. Technical Assistance. A plan will be put in place for assistance to compensate for management weaknesses. This plan can be linked to internal workshops and/or consultants or external sources such as SBDC
Attachment B:
Risk Management
Recognizing the high-risk nature of Microenterprise and small business lending, the following processes and tasks have been established to minimize the risk to the Southeastern Minnesota Microenterprise Fund.
1. The fund maintains a loan loss reserve equal to at least 15% of the total principle balance of the micro-loan fund.
2. Loan proceeds are disbursed by check, and whenever possible are written jointly to the vender and the borrower.
3. The Business Consultant and/or CEO/President makes at least one site visit prior to a loan being approved.
4. Where possible, loans are staged, i.e. a smaller initial loan is made to the borrower to limit risk and test the borrower’s ability to manage the business and repay a loan.
5. The Business Consultant and/or the CEO/President make site visits quarterly following the loan, at least for the first year, and annually thereafter.
6. During the first year following a loan, the objective of the Business Consultant is to focus, with the borrower, on the future of the business by evaluating rolling cash flow data and to assist in developing strategies to offset projected cash flow weaknesses.
7. Loan payment schedules (weekly, semi-monthly or monthly) are determined during the loan approval process, based on review of the business cash-flow projections and are set based on when the business has money.
8. The CEO/President and Board of Directors review 9. Reminder calls are made within three (3) days to borrowers whose payments are past due. Documentation of the call, the borrowers’ plan and schedule for payment are placed in the loan file and a copy sent to the Business Consultant. Follow through on promises is monitored.
Attachment C
Loan Rating Classification
The CEO/President classifies loans quarterly, and reports to the Board of Directors, according to the following rating system:
Loan Rating Classification
Classification
Risk Characterization
Reserve Level
Level #1
Excellent Loan Quality
Strong collateral 0%-5%
Level #2
Average to Above Average
Adequate collateral 5%-10%
Level #3
Average to Slightly
Below Average
All start ups 10%-20%.
Level #4
Below Average,
Problem Loans
Management and market problems 20%-50%
Level #5
Probable Loss
Bankruptcy 50%-100%
Attachment D
Loan Documentation
Following is the minimum requirements necessary to adequately document commercial loans. In all cases where the borrower is a corporation, a corporate package consisting of articles of incorporation, bylaws, corporate borrower resolution, corporate guarantees, and, in most cases, the personal guarantees of all principals will be required. In the case of a partnership, a partnership agreement and individual guarantees of the partners will be required. Appropriate documentation of any other structure will be required.
Standard Documents
Financing statements will be filed in each county and with the state.
Equipment
Vehicles
Real Estate
Note: If the Southeastern Minnesota Microenterprise Fund is taking second mortgage, verify balance of first mortgage to determine equity. Make sure the first mortgage will not apply to future advances by other lender.
SOUTHEASTERN MINNEOSTA Microenterprise FUND Loan Policy Addendum
Collateralization of loans in regards to risk management.
In typical commercial lending, cash for debt service is created through the following:
1) Cash flow from operations
2) Cash flow from personal income sources other than the business
3) Liquidation of collateral.
In micro and development lending, cash flow from operations is key. In start-ups, it doesn’t exist, and in expansions, debt service is usually in the projections. Cash flow from personal income sources other than the business hardly exists. In micro start-ups, this is the personal source of income. In existing businesses, the owners generally have everything tied up in the business and other sources will not service the level of debt. To protect the assets of a loan portfolio, more attention needs to be placed on the liquidation of collateral. Middle ground needs to be found that will provide a more stable “back end” protection of the portfolio, however, not make us a bank in the way we make credit decisions.
In preparation of bringing forward a loan request, the following collateral guidelines should be utilized. Please keep in mind this is only ONE of the underwriting criteria we will use in credit decisions and the decision will not be based only on this criteria:
LOAN AMOUNT
REQUIRED COLLATERAL VALUE AT LIQUIDATION
TECHNICAL ASSISTANCE EMPHASIS
Up to $5,000
0% (Note 1 below)
Very High
$5,000 to $25,000
80% (Note 2 below)
High
$25,000 to $35,000
90%
Moderate
Notes:
1) Collateral (as repayment) will not be a decision making factor for loans under $5,000, however, collateral, as an emotional attachment to the business shall be taken into consideration. If any form of collateral is available it should ALWAYS be asked for.
2) Use these percentages as a guideline. Under no circumstances will the fund assume collateral risk greater than $5,000 in any size loan.
GUIDELINES FOR DETERMINING LIQUIDATION VALUE OF COLLATERAL
BUSINESS ASSETS
PERCENTAGE OF MARKET VALUE
Cash
100%
Accounts Receivable
50-80%
Inventory
50-80%
Equipment
50-80%
Land Building and Improvements
80-90%
Cash: If cash (or equivalent) can be offered they are probably bankable, however, the value would be in our technical assistance. If it’s offered, take it!
Accounts Receivable: An aging should ALWAYS be requested. If it’s not available, it’s a consulting issue. Aging and quality of customers should be reviewed. Keep in mind: If the borrower cannot get paid, can we?
Inventory: Inventory is ALWAYS valued at cost and NEVER at retail. Quality and availability of inventory should be reviewed. Keep in mind: If the borrower can’t sell the inventory, can we?
Equipment: Review historical cost and replacement cost. Determine if a secondary market exists and if there are “equipment jockeys” in the industry to help liquidate. Can the equipment be relocated easily? Will it be there if we have to repossess? Is existing equipment in good shape?
Land, Building and Improvements: Always review assessed value from real estate tax statements. Secondly, appraisal if necessary. Is there a first and/or second and what are the conditions? Is the property in good shape?
PERSONAL ASSETS
PERCENTAGE OF MARKET VALUE
Guarantee
Depends of strength of personal financial statement
Retirement Accounts
0%, cannot be taken
Vehicles
Loan value from NADA
Real Estate
80-90%
You will always find emotional value attached to a personal financial statement. Ones vehicle, toys or home is always worth more to them than actual market value. Take this into consideration when reviewing the statement.
TECHNICAL ASSISTANCE GUIDELINES IN RELATION TO COLLATERAL
VERY HIGH: Requires extensive up front consulting in personal and businesses matters. Requires workshops, business plan development, management and market development, and financial projections. Requires implementation of bookkeeping systems. Will require frequent (weekly) contact from consultant after the loan is closed.
HIGH: Requires all of above with less frequent contact, semi-monthly, monthly minimum.
MODERATE: Will require less preparation time and the consulting will be very specific.
LOW: Mainly loan monitoring
s is established by the loan committee based on the risk and collateral for the loan but will not exceed 6%.
’s, SCORE, or other outside advisors.s the portfolio aging report quarterly to identify problem loans and reports status to management.
FC listed as loss payee
FC listed as loss payee
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Microenterprise Loan Fund
