So what does a “guarantee” actually mean? The guarantor must provide a payment guarantee, meaning they will make the entire payment under the terms of the note. The guarantee should be full, meaning it applies to all the amount of the borrower’s indebtedness, past, present, and future, to the lender. It should be joint and several, so the lender can pursue one or all guarantors for the payment or full amount of the loan.
With some cases, it is my opinion that you should always require a guarantee on the loan. An example would be a construction loan. Construction loans typically have more risk. If you have a small company that wants to avoid guarantees on this type of loan and have you bear all the risk, you should be extremely careful. It would be as if the customer is expecting you to bear the risk as a general contractor.
If you want to deviate from the guidelines, you will need approval from the NCUA. The reasoning should represent sound credit underwriting and not just, “I have to do it to get the deal.” The guidance letter lists the following factors that should be in place for all guarantee waivers:
· Creditworthy borrower
· Superior DSCR
· Positive income and profit trends
· Strong balance sheet and conservative debt-to-worth ratio of borrower
· Easily marketable collateral
· Low LTV
· Long relationship with the customer (5+ years)
Note that often waiving a guarantee will require additional monitoring going forward. The minimum additional steps you must take are:
· Well defined financial loan covenants
· Increased regular financial reporting that include: annual tax returns, quarterly management-prepared financials, annual GAAP prepared financial. The frequency can increase if necessary
· Well defined reporting covenants that outline penalties if the financial reporting is not done promptly
· Site visits at least yearly and more often if needed
If you are considering waiving a guarantee, consider some alternatives like requiring limited guarantees. Some deals I have been a part of had pro-rata guarantees that were limited to a certain multiple of a percent of the ownership the individual had. An example would be with a 150% of ownership guarantee, an owner of 25% of a company would provide a guarantee of 37.5% of the debt. As an aggregate, you would have total guarantees equal to 150% of the debt, though you would not be able to collect that entire amount from any one guarantor.
Releasing guarantors should also be done with care. The lender should make sure that a release does not violate any terms of the loan type, like SBA, and that the release will not produce a violation to any regulations. In my career, I have only seen releases occur with two different circumstances. The first occurred to release a spouse of a deceased partner. The company had buy-sell agreements in place to take care of the estate and the wife transferred any ownership she had to the remaining partners. The second occurred after a property was built and stabilized that had a long term credit tenant in the property with a lease term that exceeded the amortization on the loan.