Business Loan Programs

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Programs

AGENCY: Small Business Administration.

ACTION: Proposed Rule.

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SUMMARY: The U. S. Small Business Administration (SBA) is proposing to

modify its rules regarding the financing and securitization of the

unguaranteed portion of loans guaranteed under Section 7(a) of the

Small Business Act. Present regulations provide these options only to

non-depository lenders. (13 CFR 120.420, Revised as of March 1, 1996)

These proposed rules would permit both depository and non-depository

lenders to pledge or securitize the unguaranteed portions of SBA

guaranteed loans.

DATES: Comments must be received March 28, 1997.

ADDRESSES: Comments may be mailed to Jane Palsgrove Butler, Acting

Associate

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Administrator for Financial Assistance, U.S. Small Business

Administration, 409 Third Street, SW, Washington, DC 20416, Room 8200.

FOR FURTHER INFORMATION CONTACT: James W. Hammersley, Acting Deputy

Associate Administrator for Financial Assistance, (202) 205-7505.

SUPPLEMENTARY INFORMATION: Over the past several years, the average

SBA guaranty under its guaranteed business loan program (program) has

decreased from nearly 90% to approximately 75%. This 150% increase in

lender exposure requires lenders participating in the program to commit

substantially more of their own capital in order to support their

dollar volume of SBA guaranteed loans. In 1992, SBA promulgated

regulations that permitted non-depository lenders participating in the

program to pledge or securitize the unguaranteed portions of SBA

guaranteed loans, thereby permitting them to fund unguaranteed portions

of SBA guaranteed loans with the proceeds of loans and securities

offerings. (See 13 CFR Sec. 120.420, revised as of March 1, 1996.)

Since that time, bank (depository) participants have asked SBA to

modify its regulations to provide the same ability to them, in order to

offset the increase in commitment of capital needed to continue

participation in the program. Bankers have told SBA that, in many

cases, it is more efficient to raise funds through a pledge or

securitization than to attract additional deposits. Congress has now

recognized the need to permit all participants in the program to have a

level playing field in raising capital needed to fund the increased

requirement for unguaranteed portions. Therefore, recent legislation

prohibits any securitization under SBA's present regulations after

March 31, 1997, unless SBA develops regulations permitting all

participating lenders to pledge and securitize the unguaranteed

portions of their SBA guaranteed loans. See section 103(e) of Public

Law 104-408, Oct. 1, 1996, which directs SBA to promulgate a final

regulation ``that applies uniformly to both depository institutions and

other lenders * * * setting forth the terms and maintenance of

appropriate reserve requirements and other safeguards to protect the

safety and soundness of the program.''

I. Advance Notice of Proposed Rulemaking

On November 29, 1996, SBA published an advance notice of proposed

rulemaking which requested the views of interested parties on how this

statutory requirement might be satisfied. 61 FR 60,649, Nov. 29, 1996.

SBA received nine responses, including one response which had four

signatories. The comments corresponded to questions posed in the

Advance Notice Proposed Rulemaking. The following is a discussion of

the comments received.

Item one--How should lenders demonstrate a retained tangible

economic interest in a guaranteed loan? Should lenders be required to

retain an unguaranteed portion and/or a reserve? What level of

retention and/or reserve is adequate to protect the interest of SBA?

Each of the respondents provided comments on this item. One

suggested a 10% retention, one suggested a retention of 50% of the

unguaranteed portion of the loan and five suggested a retention of 5%

of the total amount of the loan. One respondent offered to work with

the Agency to develop a retention level appropriate to the credits and

one respondent proposed that a lender provide risk retention or supply

a credit enhancement of the lesser of (1) the level required to cause

all securities issued under the securitization transaction to third

parties to receive an investment grade rating, or (2) 5% of the total

outstanding principal of the loans which unguaranteed portion are

securitized.

Item two--Should we permit financing transactions on a periodic

scheduled basis or should lenders be permitted to submit transactions

whenever they want?

All of the respondents who commented on this item suggested that

there should not be a set schedule and that issuers should decide when

to take an issue to market.

Item three--Should we permit multiple lenders to ``pool''

transactions in one multi-party transaction? If so, how should this be

regulated?

Of the respondents who commented on this item, six were in favor

and one was against. Those in favor stated that pooling will be

necessary to make securitization available to small volume lenders. The

respondent opposing this idea suggested that multi-issuer pools would

allow lenders with poorer quality loans to spread their risk over a

larger number of loans.

Item four--Should we use third party resources to help process the

contemplated transactions? If so, what type of third parties? Who

should bear the costs associated with using third parties?

Only one respondent was against using third parties. This

respondent wants to keep the process as simple as possible and feels

that adding third parties will complicate the process. All others did

not object to using third parties as long as the fee for their services

was reasonable.

II. Background

In developing these proposed regulations, SBA attempted to balance

the needs of financial institutions, especially non-depository

financial institutions, to raise funds for operations with the mandate

that the program be operated on a safe and sound basis to protect the

interests of the taxpayers.

SBA has deliberated extensively over the issue of requiring a

retained economic interest in the loans. The Agency continues to

believe that the risk of loss to the originating lender has been the

cornerstone of the 7(a) loan program. For example, the Agency has

previously taken steps to reduce the premium received by lenders upon

the sale of the guaranteed portion of a loan when the Agency thought

that premiums had reached the level at which they may be reducing the

economic interest in the loans to the point that lenders would not be

cautious providers of credit.

In determining the proposed regulatory structure, the Agency also

tried to balance the ability of lenders to pledge the future income on

the loan with the need to maintain a level of safety for lenders. The

securitization structures used to date attempt to put the entire risk

of loss on the lender. In reviewing these structures, the Agency has

become concerned that there may not be a sufficient reserve available

for the entity to survive a modest increase in the historic loss rate.

One must remember that rating agencies involved in these transactions

are rating the security and the cash flows associated with it. They are

not making any type of determination as to whether the originator will

survive for the duration of the securitization.

Absent a securitization, a lender will have a guaranty on 75% of a

loan and have a 25% risk. If the unguaranteed portion of loans are

securitized, underwriters will require that the securitization be

structured so that investors are virtually protected from any loss. To

do this, securitizing lenders have had to pledge all of the cash flow

on the unguaranteed portion and a part of the cash flow on the

guaranteed portion that would otherwise be received by the lender.

Because the securitization does not change the risk of default on

loans, a lender is left in the position of assuming, in this example,

the entire risk associated with the 25% unguaranteed portion, but not

having

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the assets associated with that portion of the loan to offset its

securitization.

SBA has proposed regulations with these concerns in mind. Clearly,

it is not in SBA's interest to eliminate an avenue of funding used by

some of its lenders. Therefore, the Agency will review any final

regulations after a reasonable period of use and consider whether

changes are necessary based on experience with the structure that is

permitted.

III. Proposed Regulations

After having carefully considered all of these matters and the

responses to the advance notice, SBA is now proposing the following

regulations to satisfy the statutory requirement. The regulations being

proposed extend the coverage of the 1992 regulations to depository

lenders and propose a few changes in those regulations.

A. Technical Change

When SBA first considered securitization and pledging regulations

in 1992, it was confident that it had the resources to take over the

portfolio of a securitizing lender if the lender failed or defaulted on

its obligations under a securitization agreement. Since the

promulgation of those regulations, SBA has greatly decreased its staff.

The reduction of personnel has reduced SBA's ability to absorb

servicing and liquidation responsibilities for a large portfolio of

loans in the case of failure or default by a participating lender which

has securitized its unguaranteed portions. Therefore, as a condition to

the approval of any securitization of unguaranteed portions under the

1992 regulations, the Agency has required in securitization

documentation that a lender qualified to participate in the program,

and acceptable to SBA, identified as a back up servicer, will take over

the responsibilities required by SBA Form 750, ``Guaranty Loan

Agreement,'' for servicing and liquidation of loans made by a failed

participant. The proposed regulations incorporate this requirement.

Such servicing and liquidation must be performed under the terms of

SBA's Blanket Guaranty Agreement.

B. Extent of Securitization

SBA has had over three years to review the use of securitization by

non-depository participants. The Agency has decided that less than 100%

securitization of unguaranteed portions by lenders participating in the

program will provide them with enough capital to support adequate

levels of SBA guaranteed lending. Therefore, SBA is proposing to modify

its present regulations to require that participating lenders which

undertake securitizations retain the equivalent of at least a 5%

interest in each loan the unguaranteed portion of which is securitized.

In this regard, the proposed regulations are intended to provide a

level playing field for both depository and non-depository lenders to

securitize assets and ensure the safety and soundness of the program.

SBA intends to require that any securitizing lender demonstrate its

continuing economic interest in the securitized loans by one of the

following: (1) Retaining in its own portfolio unguaranteed portions

equal to 5% of the face value of all loans (guaranteed plus

unguaranteed portions) the unguaranteed portions of which are contained

in the securitization, (2) retaining a subordinate tranche equal to 5%

of the face value of all the loans the unguaranteed portions of which

are contained in the securitization, or (3) establishing a cash reserve

equal to 5% of the total face value of all of the loans the

unguaranteed portions of which are contained in the securitization.

Under any of the options, only the participating lender may regain use

of the proportional retained amount of funds after each corresponding

loan has been paid in full, or, in the case of a default, after the

collateral for the loan has been liquidated and a determination has

been made that there is no additional collectability.

If option (1) is used, the retained amount may be pledged as

collateral for a loan to fund the retainage. If option (3) is used, the

lender must establish the cash reserve at the time of the

securitization. The retainage in the case of option (3) must be held by

a custodian acceptable to SBA. In the event of a failure by the

securitizing lender, it must become available first to SBA to offset

expenses relative to servicing or liquidating the loans, and secondly,

to a subsequent servicer to be available for the same purposes.

C. Pledging

The 1992 regulations provided a method for non-depository lenders

to pledge the guaranteed and unguaranteed portions of their loans as a

means of financing the loans. The proposed regulations will extend the

same option to depository lenders. However under this regulation, all

lenders using a pledge agreement will be required to retain a cash flow

equal to 1% of the principal balance of any loan pledged if the

percentage of the loan pledged exceeds the unguaranteed percentage of

the loan. Thus, if a lender is pledging 100% of a portfolio of loans,

it must retain a cash flow equal to 1% of the principal balance of each

loan pledged. The documentation for the pledge must indicate that the

purpose of this holdback is to provide a sufficient reserve to pay the

cost of a new participating lender to take over servicing of pledged

loans in the event of the failure of the originating lender or its

default under the pledge agreement.

D. Capital Requirements

Presently under SBA's regulations, Small Business Lending Companies

(SBLCs), a subset of non-depository lenders, must maintain a minimum

private capital of $1,000,000 or 10% of the unguaranteed portions of

SBA guaranteed loans, whichever is more. (13 CFR 120.453) SBA is

proposing to continue the minimum capital requirement for SBLCs.

However, it is also proposing that SBLCs which securitize unguaranteed

portions and choose the option under these regulations either to retain

a percentage of the loans or a tranche of the securities must increase

their private capital by 8% of the unguaranteed portions retained or of

the tranche retained. This additional capital requirement will put

depository lenders and non-depository SBLC lenders in an equivalent

capital position with respect to SBA loans in which all or a part of

their unguaranteed portions are securitized. Thus, under this proposal,

an SBLC lender which retains a 5% tranche in a securitization, or

retains unguaranteed portions equal to 5% of the face amount of the

loans the unguaranteed portions of which are securitized must increase

its private capital by an amount equal to 8% of the retained tranche.

If the SBLC lender puts up a 5% cash reserve, the increase in capital

will not be necessary.

E. Custodial Agent

SBA is proposing that physical custody of the pertinent loan

documents relevant to pledging and securitizations be retained by the

SBA's fiscal and transfer agent (FTA) for the Section 7(a) loan

program, acting as custodian for the SBA and the parties to the

transaction. Although SBA has approved securitizations using other

entities as the custodian of the loan documents, the Agency is

concerned that increased securitization activity could make it

difficult for SBA to locate a particular borrower's note and collateral

documents if multiple custodians are permitted. Therefore, SBA is

proposing that the FTA handle this responsibility for all pledgings and

securitizations. The FTA already performs this service for several

existing transactions, and this requirement is not expected to have a

negative effect on the

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ability of any lender to pledge or securitize unguaranteed portions of

loans.

Under the proposed regulations lenders which securitize will

continue to be bound by any other regulations and requirements that

otherwise apply to lenders making SBA loans. Thus, for example, should

a denial of liability on a guaranty or suit against a lender become

necessary, SBA will hold the lender or subsequent servicer, if

appropriate, responsible. The fact that unguaranteed portions of SBA

guaranteed loans have been sold to a trust for the purpose of a

securitization will not negate the requirements of SBA Form 750,

``Blanket Loan Guaranty Agreement,'' and SBA's regulations which

require the prudent servicing of SBA loans.

Compliance With Executive Orders 12612, 12778, and 12866, the

Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork

Reduction Act (44 U.S.C. Ch. 35).

SBA certifies that this proposed rule does constitute a significant

rule within the meaning of Executive Order 12866 but would not have a

significant economic impact on a substantial number of small entities

within the meaning of the Regulatory Flexibility Act, 5 U.S.C. 601 et

seq. We believe this rule is likely to have an annual economic effect

of $100 million or more, but we request comment from the public on its

perception of the costs and benefits associated with this rule to

enable SBA to prepare a cost benefit analysis in conjunction with the

final rule. It will not result in a major increase in costs or prices,

or have a significant adverse effect on competition or the United

States economy.

The proposed rule is consistent with the mandate of section 103(e)

of Public Law 104-208 which is to set forth terms and conditions under

which sales for the purpose of securitization can be permitted,

including the maintenance of appropriate reserve requirements and other

safeguards to protect the safety and soundness of the program. We

believe that the reserve requirements and other safeguards built into

the proposed regulations satisfy this concern. For the reasons set

forth above, we feel that the proposed regulations have the benefit of

permitting SBA's lenders to support an increased volume of SBA lending

without the outlay of the cost of unguaranteed portions. There are

reasonable alternatives involving retention of less or no reserve

requirement, but we do not believe that they are as likely to uphold

the safety and soundness of the program as are the proposed

regulations. Finally, the proposed regulations have no negative impact

on State, local, or tribal governments.

For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA

certifies that this final rule contains no new reporting or record

keeping requirements.

For purposes of Executive Order 12612, SBA certifies that this rule

has no federalism implications warranting the preparation of a

Federalism Assessment.

For purposes of Executive Order 12778, SBA certifies that this rule

is drafted, to the extent practicable, in accordance with the standards

set forth in section 2 of that Order.

List of Subjects in 13 CFR Part 120

Business loans.

For the reasons set forth above, SBA proposes to amend Part 120 of

title 13, Code of Federal Regulations, as follows:

PART 120--BUSINESS LOANS

1. The authority citation for 13 CFR part 120 continues to read as

follows:

Authority: 15 U.S.C. 634(b)(6) and 636(a) and (h).

2. Section 120.420 is revised to read as follows:

Sec. 120.420 Financings by participating lenders.

(a) A participating lender may pledge the notes evidencing SBA

guaranteed loans or sell interests in such notes representing the

unguaranteed portions of such loans if SBA, in its sole discretion,

gives its prior written consent. In order to obtain that consent, the

lender must be secure financially and have a history of compliance with

SBA's regulations and any other applicable state or Federal statutory

and regulatory requirements, and agree to the terms of these

regulations.

(b) A participating lender, SBA, and any third party involved in a

pledging or securitization transaction must enter into a written

agreement satisfactory to SBA in its sole discretion which acknowledges

SBA's interest as guarantor of the subject loans and in which all

relevant third parties agree to recognize and uphold those interests

under the Act, this part, and the contractual provisions of SBA's Loan

Guarantee Agreement. In any such agreement, the parties must agree to

the following conditions:

(1) Except in extremely unusual circumstances as determined by SBA

in its sole discretion, the fiscal and transfer agent for SBA will hold

all pertinent loan instruments as designated by SBA, and the lender

will continue to service the loans after the pledge or transfer is

made.

(2) It must be demonstrated to SBA's satisfaction that the lender

retains an economic risk in and bears the ultimate risk of loss on the

unguaranteed portions. In the case of a pledge of notes, the lender

must retain all of the economic interest in the unguaranteed portion of

any loan which a pledged note evidences. In the case of a sale of

unguaranteed portions of SBA guaranteed loans to support a

securitization, the lender must agree to either hold unguaranteed

portions equal to 5% of the total amount of the loans the remaining

unguaranteed portions of which are contained in the securitization, or

purchase or retain a subordinate tranche of the securitization equal to

5% of the total principal outstanding of the loans the unguaranteed

portions of which are contained in the securitization, or establish a

cash reserve of 5% of the face amount of the loans the unguaranteed

portions of which are contained in the securitization. Any cash reserve

retainage must be held in a bankruptcy remote environment, and in the

event of a default by the lender under the securitization agreement

shall become the property of SBA to be used first to cover SBA expenses

and losses, and secondly for payment of servicing and liquidating

expenses for the loans the unguaranteed portions of which are contained

the securitization. Any retainage covered in this paragraph shall be

proportionately decreased by the payment in full of each correspondent

loan or when the collateral for each correspondent loan has been fully

liquidated and a determination has been made that there is no

additional collectability.

(c) A lender which pledges notes must retain an income stream equal

to 1% of the face amount of any notes pledged if the percentage of the

corresponding loan pledged exceeds the unguaranteed percentage. The

fund must become the property of SBA in the event of a default by the

lender under the pledging agreement to be used first to cover SBA

expenses and losses, and secondly for payment to a backup servicer of

servicing and liquidating expenses for the loans pledged.

(d) Other than for the pledging against Treasury Loans and Tax

Accounts, a lender may not use SBA guaranteed loans or the collateral

supporting such loans as collateral for any borrowing not related to

financing of the guaranteed or unguaranteed portion of SBA loans.

(e) Any pledge or securitization agreement must identify a

successor servicer to the pledging or securitizing

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lender, agreeable to SBA which will be responsible for servicing and

liquidating loans in the case of default under the agreement by the

lender. A lender, or any successor servicer under a pledge or

securitization agreement, will be considered the lender of the loan

pledged or securitized under SBA rules, and will be bound by all

restrictions that otherwise apply to lenders making SBA loans as long

as either continues to act as servicer. SBA will hold the lender or

successor servicer responsible in the case of a denial of liability or

other adjustment to the amount of any SBA guaranty.

Sec. 120.470 [Amended]

3. Section 120.470(b)(3) is amended by adding the following

sentence at the end thereof:

* * * * *

(b) * * *

If pursuant to Section 420 of these regulations an SBLC sells the

unguaranteed portion of loans and retains either an amount of

unguaranteed portions equal to 5% of the total amount of the loans the

unguaranteed portions of which are contained in securitization, or a

subordinate tranche of a securitization equal to 5% of the face value

of the loans the unguaranteed portions of which are contained in the

securitization, it must increase its private capital by 8% of either

the face value of the unguaranteed portions of the loans retained or 8%

of the face value of the subordinate tranche.

Dated: February 12, 1997.

Ginger Ehn Lew,

Acting Administrator.

[FR Doc. 97-4785 Filed 2-25-97; 8:45 am]

BILLING CODE 8025-01-P