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WASHINGTON — One of America's major lenders of small business administration loans has been sharply rebuked by the Small Business Administration for participating in financial chicanery. The bank accepted unrealistic earnings projections for Huntington Learning franchises when they should have known better.
As the country plunged into recession in 2008, Banco Popular was the country's 16th largest issuer of SBA-backed business loans, according to a 2009 BusinessWeek article.
But these are humbler times and Banco Popular now finds itself scolded by the government. The earnings projections used by Popular to qualify for a small business loan for a Huntington Learning Center franchise have been found to be habitually overstated. The problem is that there is published information to show those projections to be pie-in-the-sky.
It was discovered that the bank had not followed important SBA mandates for obtaining loans backed by U.S. taxpayers. These are government-guaranteed loans for lenders who normally would not provide a conventional loan to a borrower. Congress established this mechanism when the SBA was established in 1953. The SBA guarantees payment to the bank should the borrower fail to be able to pay back the loan.
"If Banco Popular had complied with SBA's requirements and used revenue projections that were realistic, the 12 HLC [Huntington Learning Center] franchise loans should have been declined due to lack of repayment ability," wrote John Needham, SBA Assistant Inspector General, in a 14-page report.
What the SBA's Office of Inspector General found was that all of the franchise earnings projections for Huntington Learning Centers were bogus. "Of the 12 loans approved, 10 loans with an aggregated outstanding SBA balance of $2.1 million had been transferred to liquidation as of December 2010. Four of the ten loans defaulted within 18 months," the assistant inspector general stated.
Projected revenues, which are used to determine if a franchise will be a viable loan candidate, were artificially high. The franchise offering circular stated that the average revenue of all its franchises in business for longer than a year was 468,422 in 2005. But in order to qualify for government-guaranteed loans, Banco Popular showed the SBA that the franchisees were expected in their very first year to perform considerably higher: from $483,000 to $650,000.
'Franchises are safer' myth harms banks
When asked how such bogus numbers were habitually put into SBA loan applications for Huntington franchisees, the vice president at Banco Popular who oversees small business loans told the Inspector General that franchises require a lesser degree of due diligence because of the franchise model. "The vice president further stated that the upfront training and marketing assistance in franchise businesses increases the likelihood that businesses will achieve their projections," wrote the Assistant Inspector General in the report (pdf).
The myth that franchises are safer than independent small business establishments goes against the SBA's experience. In fact, the SBA warned lenders that it found the opposite to be the case.
In September of 2002, the "SBA's Experience With Defaulted Franchise Loans" publication concluded: "Despite the popular view that franchisees are much more successful than non-franchisees, SBA's experience with defaulted loans does not support this." The SBA also cautioned its preferred lenders: "Franchisors have an incentive to encourage as many prospective entrepreneurs as possible to become franchisees and find financing. Moreover, there is always a risk of some franchisors' overly optimistic financial projections enabling under qualified prospective franchisees to obtain – and default on – SBA guaranteed loans."
Frances Del Valle, a spokesperson for Banco Popular, explains to Blue MauMau readers that for reasons of liability, the bank does not reveal particulars about a borrower's situation. Besides minimizing potential litigation from franchisees who took out their loans based on bad numbers, the company also wants to repair any damage it has with the SBA. "Banco Popular has a collaborative relationship with the SBA," she emphasizes. "We aren't the only ones going through major overhaul, restructuring and reorganization," she adds.
The bank is trying to piece together what went so very wrong in its franchise lending. "We are committed to delivering sound underwriting practices and view this past opportunity as a way to further enhance those practices," emphasizes Del Valle.
But experts are saying Banco Popular has merely done what other major franchise lenders do.
Darrell Johnson, the chief executive officer of Frandata, a research firm and provider of franchise credit reports, says that at the heart of this problem is the ability of a bank to get credible information. "Since most franchisees do not have previous history with a particular brand, the lender must make such judgments on their own," says Johnson.
|SBA OIG Audit Report 7.201unredacted.pdf||8.08 MB|