Business Loan Programs

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Programs

AGENCY: Small Business Administration.

ACTION: Notice of proposed rulemaking and public hearing.

-----------------------------------------------------------------------

SUMMARY: The U.S. Small Business Administration (SBA) proposes a rule

to allow all participating Lenders to sell, securitize, sell a

participating interest in, or pledge the unguaranteed portion of 7(a)

loans. The proposal has two components: securitizations; and pledges,

sales of participations, and sales other than for the purpose of

securitizing. In the first component, SBA establishes a three level

unified approach to regulating securitization. This approach would

apply to all securitizers and is designed to help ensure the safety and

soundness of the 7(a) program. The approach focuses on the quality of

the securitizer's underwriting and servicing and the performance of the

securitizer's loans. In the second component, SBA sets forth the

requirements that Lenders must meet to pledge, sell a participating

interest in, or sell (other than for the purpose of securitizing) 7(a)

loans. If this proposal becomes final, it would replace the present

Interim Final Rule published on April 2, 1997, at 62 FR 15601 (the

``Interim Final Rule''). The proposed rule would amend 13 CFR

Sec. 120.420, add Secs. 110.421-120.429, renumber Secs. 120.430 and

120.431 as Secs. 120.414 and 120.415, and add Secs. 120.430-120.435. In

addition, SBA is providing notice of a public hearing set for 2:00 p.m.

on June 4, 1998. The hearing will provide the public an opportunity to

comment orally on the proposed rule.

DATES: Submit comments July 17, 1998. SBA will hold a public hearing to

receive oral comments on June 16, 1998, at 2:00 p.m. at the U.S. Small

Business Administration, 409 Third Street, S.W., Washington, D.C., 8th

Floor Eisenhower Conference Room.

ADDRESSES: Mail comments to Jane Palsgrove Butler, Acting Associate

Administrator for Financial Assistance, U.S. Small Business

Administration, 409 Third Street, S.W., Suite 8200, Washington, D.C.

20416.

FOR FURTHER INFORMATION CONTACT: James W. Hammersley, Director,

Secondary Market Sales, 202-205-6490.

SUPPLEMENTARY INFORMATION: SBA is proposing a new regulation governing

the securitization of the unguaranteed portion, sale, sale of a

participating interest in, or pledge of SBA 7(a) loans. The rule has

two components. The first component governs securitizations. For

purposes of this regulation, a securitization is the pooling and sale

of the unguaranteed portion of SBA loans, usually to a trust or special

purpose vehicle, and the issuance of securities backed by those loans

to investors in either a private placement or a public offering

(``securitization''). In the securitizations of SBA loans to date, each

investor has received an undivided ownership interest in the right to

receive the principal of the unguaranteed portion of the pooled SBA

loans, together with interest. As a credit enhancement, the securitizer

usually transfers to the trust or special purpose vehicle, for the

benefit of investors, a portion of the interest on each pooled loan

representing the difference between the interest paid by the SBA loan

borrower and the interest paid to the holder of the guaranteed

interest, the holder of the securitized interest and various

administrative fees (the ``Excess Spread'').

The second component of this proposed rule deals with pledges of,

sales of participating interests in, and sales other than for the

purpose of securitizing SBA loans.

I. Securitization Component

Regulatory History

Congress and SBA have examined whether and under what conditions

SBA should permit Lenders to securitize the unguaranteed portion of

7(a) loans. Recognizing that Small Business Lending Companies and

Business and Industrial Development Companies and other nondepository

institutions (''nondepository institutions'') do not have customer

deposits to fund 7(a) lending, SBA in 1992 began permitting

nondepository Lenders to securitize. In 1996, Congress and SBA

considered extending the authority to securitize to depository Lenders.

On September 29, 1996, Congress enacted legislation requiring SBA, by

March 31, 1997, either to promulgate a final rule allowing both

nondepository and depository Lenders to securitize or cease approving

securitizations.

In response to the legislative mandate, on November 29, 1996, SBA

published an Advance Notice of Proposed Rulemaking (61 FR 60649)

seeking public comments on securitizations in advance of its

publication of proposed regulations. On February 26, 1997, SBA

published a Proposed Rule (62 FR 8640) requiring a 5 percent retainage

for all securitizations. SBA received approximately 25 comments; the

commenters were divided almost equally in their response to SBA's

proposal.

On April 2, 1997, SBA promulgated the Interim Final Rule (62 FR

15601). This regulation allowed all SBA Lenders to securitize while SBA

continued its thorough review of securitization issues. Recognizing the

complexity of the subject, SBA decided to hold a public hearing and

consult bank regulators and other experts. While doing so, it has

reviewed each proposed transaction on a case-by-case basis under the

Interim Final Rule to protect the safety and soundness of the 7(a)

program.

During its review process, SBA convened a public hearing at which

interested parties publicly stated their views on securitization and

related safety and soundness issues. SBA engaged securitization and

accounting experts, and consulted representatives from bank and other

financial regulatory agencies, including the Federal Deposit Insurance

Corporation (FDIC), Office of the Comptroller of the Currency (OCC),

Department of the Treasury, the Federal Reserve Board, Office of

Federal Housing Enterprise Oversight and Office of Thrift Supervision

(OTS).

SBA has carefully considered all views and comments expressed by

these experts, bank regulators, and the industry, and has incorporated

many of the comments and recommendations into a unified regulatory

approach consisting of three levels. In January of 1998, SBA discussed

its three level approach with representatives of the bank regulatory

agencies.

SBA believes this proposal is an improvement over the Interim Final

[[Page 27220]]

Rule. The levels would apply uniformly, providing equal treatment to

depository and nondepository institutions and addressing the

possibility of increased risk to the SBA portfolio from securitization.

The rule provides incentives for Lenders to maintain high underwriting

and servicing standards to minimize delinquencies and defaults.

Appropriately, the financial impact of the proposal on a particular

securitizer would depend on the performance of the securitizer's loans.

If the securitizer's loan performance has been good historically and

remains consistent or improves during the period that a securitization

is outstanding, the financial impact on the securitizer would be

minimal. However, if a securitizer's loan performance has been below

average historically or declines during the period that the

securitization is outstanding, consequences to the securitizer would be

greater. The new approach ties securitizer risk retention to

securitizer long-term credit performance and considers the long-term

credit cycle of SBA loans.

This proposed rule considers historic SBA loan data and is

consistent with bank regulatory policy and marketplace risk management.

The rule would facilitate the use of securitizations by setting forth

clear and consistent standards. Compared to the Interim Final Rule, SBA

believes the proposed rule would be better for taxpayers, better for

Lenders, and better for small businesses.

Securitization Risks

SBA supports securitization because it encourages Lenders to make

more SBA-guaranteed loans to America's small businesses. While

securitization can provide enormous benefits, SBA has concerns that

under certain circumstances or economic conditions the securitization

process might encourage poor credit quality and increase SBA's losses

on the guaranteed portion of its loans.

Securitization provides a market for large volume sales of SBA

loans. Therefore, securitizers have an incentive to make loans quickly

and record the profits from the securitization. Furthermore, if Excess

Spread Income from previous securitizations declines, a securitizer

might use the profits from new issues to offset the decline. These

circumstances create a risk that securitizers might compromise credit

quality in order to make more loans more quickly to increase profits.

Also, the securitization of the unguaranteed portions of small

business loans is relatively new and has developed during the strong

part of a business cycle. It is not clear what effect a downturn in the

economy will have on the credit quality of individual securitizers and

on the performance of securitized loans.

Under Financial Accounting Standards Board Statement Number 125

(``FASB 125''), a securitizer's earnings and capital grow faster than

the earnings and capital of a non-securitizer making the same loans.

FASB 125 requires Lenders that securitize loans and retain the

servicing to recognize immediately the full amount of future income

attributable to the securitized loans. This ``gain-on-sale'' income is

calculated by discounting a stream of future income. The approach

assumes an average life of the underlying loans, future servicing

expenses, and loan losses. Securitization and FASB 125 have a direct

effect on a securitizer's bottom line. The more loans a securitizer

makes and the faster it makes them, the greater the securitizer's

profits. Some experts have expressed concerns that this can lead to

pressure for a securitizer to increase volume by potentially relaxing

underwriting standards or reducing resources devoted to servicing.

SBA's response to these concerns is to focus, through this proposed

rule, on credit quality.

To control risk, SBA historically has relied on a Lender's

retention of a significant economic interest in the unguaranteed

portion of 7(a) loans. Lender risk retention has been the cornerstone

of SBA's guarantee program. A Lender that sells the entire unguaranteed

interest in a loan might be less accountable for losses because the

unguaranteed portion is no longer available as a risk sharing

mechanism.

Therefore, in its review, SBA has sought meaningful risk retention

mechanisms that encourage securitizers to originate loans of

appropriate credit quality while not discouraging securitization. SBA

has analyzed a number of questions relating to such risk retention

including: How should SBA structure risk retention to ensure that each

Lender retains sufficient economic exposure to maintain high

underwriting and servicing standards? Should SBA require securitizers

to hold back a portion of their loans from securitization, retain

subordinated securities issued in the securitization (a ``subordinated

tranche''), or reserve cash? How much should the securitizer retain,

purchase, or reserve? Who should determine the retainage amount, SBA or

the rating agencies? What additional components should SBA require as a

complement to a retention? Are there credit quality or loan performance

standards which should trigger additional consequences? Supported by

expert advice, SBA has now developed the following unified approach to

regulating securitizations.

The Unified Regulatory Approach

This proposed rule does not rely solely on retention to encourage

Lenders to maintain high credit quality and underwriting and servicing

standards. Instead, it contains several progressive levels. The levels

are:

(1) A consistent and enforceable capital requirement;

(2) A retention requirement (subordinated tranche); and

(3) Suspension of a securitizing PLP Lender's unilateral loan

approval privileges (``PLP approval privileges'') if the currency rate

(the percentage of loans that are less than 30 days past due) of the

loans in the securitizer's portfolio deteriorates over time.

SBA believes this approach is superior to SBA's February 1997

securitization proposal that suggested a 5% retention requirement on

all securitizers at the beginning of the securitization without regard

to the securitizer's credit quality history or the subsequent

performance of the securitized loans. The unified approach imposes a

smaller economic impact on the securitizer initially, but establishes

credit quality standards which, if not met during the life of a

securitization, trigger increased scrutiny of the securitizer's

underwriting. It provides securitizers with appropriate incentives tied

to actual credit performance, affords SBA the protection it seeks for

itself and taxpayers, and still facilitates securitization for all

originators. A more detailed discussion of each level follows.

The Capital Requirement

A capital requirement is a basic component of the regulation of any

financial institution. It is a common method for measuring a Lender's

financial strength.

SBA is in the process of considering capital requirements for all

its participating Lenders. Although maintenance of minimum capital is

important for all SBA participating Lenders at all times, SBA believes

the maintenance of minimum capital is especially important with respect

to securitizers. Requiring the securitizer to maintain a minimum level

of capital encourages prudent underwriting and servicing practices.

Credit quality is fundamental to the maintenance of capital. Loan

losses erode capital. As well as being a measure of reduced

[[Page 27221]]

financial strength, eroding capital may signal weakening credit

quality.

To emphasize the significance SBA attaches to a securitizer's

compliance with capital requirements, SBA has designated the

maintenance of minimum capital as the first level of its unified

approach for regulating securitization. The proposed rule would require

all depository and nondepository securitizers to maintain minimum

capital consistent with the requirements imposed on depository

institutions by the Federal Reserve Board, the FDIC, the OCC, and the

OTS (the ``bank regulatory agencies'').

For depository Lenders, SBA's capital requirement would not add to

that which is already required by the bank regulatory agencies. Thus,

this proposed rule should have no independent effect on depository

institutions that already comply with capital requirements imposed by

the bank regulatory agencies.

This proposed rule would apply to all securitizing nondepository

institutions, including SBLCs, Business and Industrial Development

Companies (``BIDCOs''), and other institutions approved for

participation in SBA's loan programs. As the Federal agency with

primary responsibility for regulating SBLCs, SBA has had a capital

requirement for SBLCs in its regulations since 1975. SBA's capital

requirements for SBLCs have not always been consistent with the capital

requirements imposed by the bank regulatory agencies on depository

institutions. For example, SBA's current SBLC regulations include a 10%

capital requirement on the SBLC's share of all outstanding loans. At

present, the capital requirement for depository institutions imposed by

bank regulatory agencies applicable to comparable assets is 8%.

Further, SBA's present capital requirement regulation does not consider

the recourse issues associated with securitization already addressed by

the bank regulatory agencies. SBA believes that conforming its capital

requirements for securitizing SBLCs to general bank regulatory policy

known and understood by the lending community would eliminate confusion

and create a consistent and level playing field.

SBA currently requires SBLCs to maintain a minimum unencumbered

paid in capital and paid in surplus equal to at least $1 million. SBA

believes that a securitizing nondepository institution should have such

minimum capital. Therefore, in addition to the requirements of bank

regulatory agencies, SBA will require securitizing nondepository

institutions to maintain such minimal capital. SBA also currently

requires SBLCs to provide to SBA annual audited financial statements

demonstrating that SBA's present capital requirement is met. The

proposed rule would require all securitizing nondepository Lenders to

submit such audited financial statements.

The Retention of a Subordinated Tranche

As proposed, SBA would require securitizers to retain a

subordinated tranche equal to the greater of (a) twice the loss rate

(the SBA charge off rate) experienced on a securitizer's SBA loans,

originated or purchased, for a 10-year period or (b) 2% of the

unguaranteed portion of the securitized loans. These securities would

be subordinate to all other tranches issued. Based on historical data,

SBA expects that most securitizers' retention levels would be between

12 and 2%. The current average would be 5.4% for SBA's high volume

Lenders. (See the loss rates in Chart 1 below). It is a common practice

for retention percentages to be based on multiples of expected losses.

For example, rating agencies use a multiple of expected losses as part

of the formula to determine the minimum amount a securitizer must

deposit in the spread account. The 2% minimum approximates twice the

cumulative loss rate of the best performing SBA loan originators.

Currently, only four of the high volume Lenders referred to in Chart 1

would be below the 2% minimum threshold. Even for the best

securitizers, SBA believes the minimum subordinated tranche is

necessary to counter the potential risks of securitizing.

[[Page 27222]]

[GRAPHIC] [TIFF OMITTED] TP18MY98.016

SBA is aware that a downturn in regional economic conditions may

affect securitizers' loss rates adversely even though the securitizers'

underwriting and servicing standards remain high. Under those

circumstances, the rule would permit SBA to modify the formula for the

retention size, if its enforcement might exacerbate the adverse

economic conditions in the region.

The retention requirement addresses SBA's concern that unusually

large losses may occur early in the life of loans originated by a

rapidly growing securitizer which may not be covered by Excess Spread

or reflected in a securitizer's historical performance. SBA believes

the proposed retention requirement is fair because there is a direct

relationship between the size of the subordinated interest that a

securitizer must retain and the securitizer's own historical

performance. The proposed approach should give securitizers an added

incentive to originate, purchase, and service high quality loans.

Under the proposed rule, securitizers would be able to sell the

subordinated tranche at market value after retaining the tranche for

six years. SBA's historical loss data indicates that its Lenders incur

most losses between years three and five of a twenty-five year loan

(see Charts 2 and 3). If the loans do not perform as expected, not only

may the securitizer suffer losses, but the tranche will have

significantly less value if the securitizer tries to sell it after the

holding period ends. For this reason, requiring securitizers to hold

the tranche for the six year period reinforces the incentive to

originate and service high quality loans.

Chart 2

[In percent]

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Defaults Total Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

0-6 year maturity................................... 10.02 0.12 2.10 3.33 2.42 1.18 0.46 0.12 0.16 0.06 0.03 0.02 0.01 0.01

6-12 year maturity.................................. 17.02 0.09 2.56 4.92 4.00 2.38 1.42 0.89 0.35 0.18 0.10 0.06 0.04 0.03

12-18 year maturity................................. 14.67 0.05 1.43 3.42 3.20 2.28 1.45 1.00 0.68 0.37 0.34 0.19 0.20 0.05

Over 18 years....................................... 18.11 0.05 1.16 3.32 3.36 2.89 2.32 1.50 1.19 0.66 0.64 0.42 0.45 0.14

1998 Cohort......................................... 16.11 0.08 1.87 3.96 3.46 2.37 1.60 1.01 0.65 0.35 0.30 0.20 0.20 0.07

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 27223]]

[GRAPHIC] [TIFF OMITTED] TP18MY98.017

SBA selected a subordinated tranche as the retention level in its

unified approach to regulating securitizations for several reasons.

Unlike a retained pro-rata interest in the entire loan, or a cash

reserve dedicated to SBA, a retained subordinated interest is a

retained economic interest that benefits both SBA and investors.

Several commenters and experts have suggested to SBA that such an

interest is more sensitive to losses than other available options. The

use of a subordinated tranche also is widely accepted by rating

agencies and investors.

Unlike a menu of possible retainage options and combinations,

retention of a subordinated tranche is a single, simple and uniform

requirement. It introduces greater certainty to a developing market and

makes it easier to compare one issue of securities with another. A cash

reserve in SBA's control also would be less desirable to securitizers

because such a reserve would earn less due to required conservative

investing.

The size of the subordinated tranche is directly related to loan

experience. The three options in SBA's proposed rule (62 FR 8640) of

February 26, l997 established a set retention level equal to 5% of the

entire loan, which is equal to 20% of the unguaranteed portion of a

typical loan, without regard to credit quality or any measurable

economic impact. SBA believes an empirically-based retention percentage

is superior to a set 5% retention level because it reflects the credit

quality and historical loan performance of the securitizer.

SBA has always required Lenders to maintain a meaningful economic

interest in SBA guaranteed loans in order to protect the taxpayer. A

number of past comments have suggested that SBA need not impose any

retainage requirement because securitizers retained a sufficient

continuing economic interest in the Excess Spread. These commenters

argued that credit losses taken against the Excess Spread result in

meaningful economic consequences to a securitizer that has recognized

the present value of the future excess cash flow as income. SBA agrees

with much of this argument. It acknowledges that the discipline and

methodology imposed by, and the information generated by, the rating

agencies provide valuable protection to SBA. Nevertheless, SBA has

decided not to rely solely on rating agencies to set retention levels.

SBA believes that sole reliance on Excess Spread is not enough to

protect taxpayers in the event of deteriorating loan performance. The

market uses the Excess Spread to protect the investor, not the

taxpayer. Some commenters and experts have asserted that reliance on

securitization may change a securitizer's behavior and increase risk to

the taxpayer. Since taxpayers have a greater dollar exposure on each

loan than any investor, SBA believes it needs economic incentives in

addition to those the market provides to ensure the safety and

soundness of the 7(a) program.

Suspension of PLP Approval Privileges

For purposes of this proposed rule, if the currency rate of a PLP

securitizer declines, SBA would suspend that securitizer's PLP approval

privileges under two circumstances: (a) if the rate of decline is more

than 110% of the rate of decline of the currency rate of all loans

approved under the PLP program (PLP Program Loans) as calculated from

quarter to quarter or (b) if the decline is more than five percentage

points when the currency rate of the PLP Program Loans remains stable

or increases. If the securitizer's currency rate remains stable or

improves, the securitizer may continue to use PLP procedures for loan

approval. SBA plans to calculate and compare the currency rate for PLP

Program Loans and the currency rate for each securitizer's portfolio

each quarter.

[[Page 27224]]

By suspending PLP approval privileges and requiring a Lender to

submit all of its loans through SBA's field offices for approval, SBA

can monitor a securitizer's credit practices more closely. Ideally, SBA

will be able to identify declining loan performance before it can

threaten a securitizer's entire portfolio and financial condition. SBA

monitoring may assist the securitizer to improve credit practices while

protecting the safety and soundness of the program. SBA may reactivate

the securitizer's PLP approval privileges at any time.

Based on an analysis of changes in the currency rate of the SBA

portfolio over the past 16 years, SBA estimates that few securitizing

PLP Lenders will be subject to the privilege suspension (see Charts 4

and 5). However, SBA recognizes that a downturn in the economy might

trigger suspension for a greater number of PLP Lenders. Consequently,

SBA has included in this rule a provision allowing SBA to waive

suspension of PLP approval privileges for securitizers in an area where

currency rates have been adversely affected by a downturn in regional

economic conditions, if enforcing this element might exacerbate the

adverse economic conditions in the area.

Chart 4

----------------------------------------------------------------------------------------------------------------

Currency Absolute 110% of

Year ending rate value of Percentage percent

(percent) change change change

----------------------------------------------------------------------------------------------------------------

1980........................................................ 80.20 ........... ........... ...........

1981........................................................ 77.70 0.0250 3.12 3.43

1982........................................................ 76.20 0.0150 1.93 2.12

1983........................................................ 75.50 0.0070 0.92 1.01

1984........................................................ 76.80 0.0130 1.72 1.89

1985........................................................ 78.00 0.0120 1.56 1.72

1986........................................................ 81.30 0.0330 4.23 4.65

1987........................................................ 80.90 0.0040 0.49 0.54

1988........................................................ 83.50 0.0260 3.21 3.54

1989........................................................ 84.70 0.0120 1.44 1.58

1990........................................................ 86.90 0.0220 2.60 2.86

1991........................................................ 86.20 0.0070 0.81 0.89

1992........................................................ 87.60 0.0140 1.62 1.79

1993........................................................ 88.80 0.0120 1.37 1.51

1994........................................................ 90.90 0.0210 2.36 2.60

1995........................................................ 90.60 0.0030 0.33 0.36

1996........................................................ 89.40 0.0120 1.32 1.46

Average Change.............................................. ........... 0.0149 ........... ...........

Standard Dev................................................ ........... 0.0084 ........... ...........

----------------------------------------------------------------------------------------------------------------

Cells in bold represent years when the currency rate increased, therefore the 5 percentage point test would

apply.

[GRAPHIC] [TIFF OMITTED] TP18MY98.018

SBA reviewed numerous methodologies to determine an equitable and

effective way to measure a securitizer's credit quality and to

establish a basis for comparison to overall portfolio behavior. SBA

believes that currency rate is a reliable predictor of future losses.

SBA also believes the thresholds it has selected are fair and would

trigger economic consequences to the securitizer only if loan

performance seriously declines.

Additional Levels

One of SBA's consultants proposed a fourth level to SBA's approach

to regulating securitization which level would be based on a

securitizer's loss rates and, therefore, be tied to long-term

[[Page 27225]]

performance. The consultant recommended that the fourth level be a

supplemental payment. SBA would impose a supplemental payment equal to

1 percent of the outstanding balance of the securitization based on the

performance of the loans in the securitization. If the securitization

loss rate (1) remained the same, (2) declined, (3) increased by no more

than 5 percent from year to year, or (4) was no more than 2 percent,

than a supplemental payment would not be due. If, however, a

securitization loss rate was over 2 percent and increased by more than

5 percent, the securitizer would be required to make a supplemental

payment with respect to that securitization, if (a) the percentage

change in the securitization loss rate was at least two times any

percentage increase in SBA's loan portfolio loss rate or (b) the

securitization loss rate is twice the loss rate of SBA's loan

portfolio, and the loss rate for the SBA loan portfolio remained stable

or declined. The provisions of this additional level would apply to a

securitization only during the period the subordinated tranche would be

required to be held. SBA would limit the supplemental payment to the

holding period because it is during this crucial period that Lenders

historically have experienced the highest loan losses.

Imposing an economic consequence if a securitizer's loan portfolio

begins to show significant increases in losses would give a securitizer

an additional direct financial incentive to maintain credit quality.

Others with whom SBA has consulted agree that this would be an

appropriate progression within SBA's regulatory approach. SBA is

predisposed to add a fourth level featuring a direct financial

incentive to its unified approach to securitization, but recognizes

that it lacks legislative authority to impose new direct fees on its

Lenders. SBA will be considering this matter further and welcomes

comment on the subject.

In addition to the levels proposed, the rule would: a) require that

SBA's Fiscal and Transfer Agent (``FTA'') hold all original promissory

notes; (b) prohibit Lenders from securitizing loans not yet closed and

fully disbursed; and (c) allow SBA to require all securitizers to use

SBA's model multi-party agreement and model pooling and servicing

agreement once developed. The use of the model agreements would

expedite processing.

Multi-Lender Securitizations

Although SBA has not yet approved a multi-Lender securitization, it

believes that low volume Lenders should have the same access to

securitization as high volume Lenders. SBA expects that the market will

develop the structures necessary to permit low volume Lenders to

securitize. Several ideas are in the early stages of development. As

part of this proposal, SBA is soliciting comments to assist it in

formulating multi-Lender securitization requirements. What criteria

should SBA use to review multi-Lender securitizations? Are there unique

risks inherent in a multi-Lender transaction? Should all Lenders be

eligible to participate in a multi-Lender transaction or should only

Preferred Lender Program (``PLP'') Lenders be able to participate?

Should each participant in the multi-Lender securitization be required

to comply with the levels contained in this proposed rule? Does SBA

need safeguards for multi-Lender securitizations in addition to those

in this proposed role to ensure credit quality and loan performance and

protect the safety and soundness of the 7(a) program?

II. Other Conveyances Component

The Other Conveyances component governs pledges and sales other

than sales for the purpose of securitizing. This proposed rule would

require SBA's prior written consent for the sale of a Lender's entire

interest in a loan to another participating Lender. It would permit,

with prior written notice to SBA, a sale after which the SBA Lender

would continue to own a portion of the unguaranteed interest equal to

at least 10% of the outstanding principal amount of the loan. This

proposed rule would permit a Lender to sell an even greater portion of

the loan as long as the sale received SBA's prior written consent,

which consent could be withheld in SBA's sole discretion. The rules for

sales of participating interests mirror those for sales. By allowing

Lenders to sell the unguaranteed portion of their SBA loans in this

manner, SBA encourages Lenders to make small business loans while

protecting the safety and soundness of the 7(a) program.

Like the Interim Final Rule (62 FR 15601), this proposal also would

require that a Lender obtain SBA's written consent prior to all pledges

of SBA loans except for certain types of pledges enumerated in 13 CFR

Sec. 120.435. Except for such enumerated pledges, the SBA Lender must

use proceeds of the loan secured by the SBA loans solely for the

purpose of financing additional SBA loans. The provisions for pledging

are almost unchanged from the Interim Final Rule.

Finally, this proposal incorporates several elements set forth in

the Interim Final Rule and requires that a Lender be in good standing

as determined by SBA. All documentation, including the multi-party

agreement, must be satisfactory to SBA. The proposed rule also would

require that a Lender or a third party acceptable to SBA hold the

original promissory notes.

SBA seeks comments on all aspects of the proposal. In particular,

SBA seeks comments suggesting any other level which it might

incorporate in its unified regulatory approach as an additional

incentive to securitizers to maintain high underwriting and servicing

standards. For example, should additional action (beyond suspension of

PLP approval privileges) be taken if a securitizer's loss rate declines

significantly?

While this proposed rule is pending, SBA will continue to review

proposed securitizations on a case by case basis under the Interim

Final Rule.

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 would not constitute a

significant rule within the meaning of Executive Order 12866, since it

is not likely to have an annual effect on the economy of $100 million

or more, result in a major increase in costs or prices, or have a

significant adverse effect on competition or the United States economy.

SBA certifies that this proposed rule 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. This

proposed rule is intended to replace SBA's Interim Final Rule published

on April 2, 1997. Like the Interim Final Rule, it would allow

depository Lenders to securitize loans (as nondepository Lenders have

done for the last six years). Since the publication of SBA's Interim

Final Rule almost one year ago, only one depository Lender has

securitized. Moreover, that Lender would not qualify as small under

SBA's size standards. 13 CFR Sec. 121.201. SBA will consider any

additional information from the public on its assessment of the impact

of this proposed rule on small banks, nondepository institutions or

other small businesses.

SBA certifies that this proposed rule would not impose any

additional reporting or recordkeeping requirements under the Paperwork

Reduction Act, 44 U.S.C. chapter 35.

For purposes of Executive Order 12612, SBA certifies that this

proposed

[[Page 27226]]

rule would have no federalism implications warranting preparation of a

Federalism Assessment.

For purposes of Executive Order 12778, SBA certifies that this

proposed rule has been drafted, to the extent practicable, to accord

with the standards set forth in section 2 of that Order.

List of Subjects 13 CFR Part 120

Loan programs--business, Reporting and recordkeeping requirement,

Small businesses.

For the reasons set forth above, SBA proposes to amend 13 CFR part

120 as follows:

PART 120--[AMENDED]

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. Revise Sec. 120.420 to read as follows:

Financings By Participating Lenders

Sec. 120.420 Definitions:

Bank regulatory agencies--The bank regulatory agencies are the

Federal Deposit Insurance Corporation, the Federal Reserve Board, the

Office of the Comptroller of the Currency, and the Office of Thrift

Supervision.

Currency rate--A securitizer's ``currency rate'' is the dollar

balance of its SBA guaranteed loans that are less than 30 days past due

divided by the dollar balance of its outstanding portfolio of SBA

guaranteed loans, as calculated by SBA.

Good standing--A securitizer is in ``good standing'' with SBA if it

is in compliance with all applicable laws and regulations, policies and

procedures, is in good financial condition as determined by SBA, and is

not under investigation, indictment for, has not been convicted for or

had a judgment entered against it or have any officers or employees who

have been convicted, indicted, under investigation or the subject of a

civil judgment for a felony or charges relating to a breach of trust or

violation of a law or regulations protecting the integrity of business

transactions or relationships.

Loss rate--A securitizer's ``loss rate'', as calculated by SBA, is

the aggregate principal amount of the securitizer's SBA guaranteed

loans determined uncollectable by SBA for the most recent ten year

period, excluding current fiscal year activity, divided by the

aggregate original principal amount of SBA guaranteed loans disbursed

by the securitizer during that period.

Nondepository institution--A ``nondepository institution'' is a

Small Business Lending Company regulated by SBA (''SBLC'') or a

Business and Industrial Development Company (``BIDCO'') or other

nondepository institution participating in SBA's 7(a) program.

Securitization--A ``securitization'' is the pooling and sale of the

unguaranteed portion of SBA guaranteed loans to a trust, special

purpose vehicle, or other mechanism, and the issuance of securities

backed by those loans to investors in either a private placement or

public offering.

3. Add Sec. 120.421 through 120.428 to read as follows:

Sec. 120.421 Which Lenders may securitize?

All SBA participating Lenders may securitize.

Sec. 120.422 Are all securitizations subject to these regulations?

All securitizations are subject to the regulations in this part.

SBA will consider securitizations involving multiple Lenders on a case

by case basis. SBA will use the conditions in Sec. 120.425 as a

starting point for reviewing multiple Lender securitizations.

Securitizations by affiliates are considered single Lender

securitizations for purposes of the regulations in this part.

Sec. 120.423 Which SBA loans may a Lender securitize?

Notwithstanding the provisions of Sec. 120.453(c), a Lender may

only securitize guaranteed loans that are fully disbursed by the

closing date of the securitization. If the amount of a fully disbursed

loan increases after a securitization settles, the Lender must retain

the increased amount.

Sec. 120.424 What are the basic conditions a Lender must meet to

securitize?

To securitize, a Lender must:

(a) Be in good standing as determined by the Associate

Administrator for Financial Assistance (AA/FA);

(b) Use a securitization structure which is satisfactory to SBA;

(c) Use documents acceptable to SBA, including SBA's model multi-

party agreement;

(d) Obtain SBA's written consent, which it may withhold in its sole

discretion, prior to executing a commitment to securitize; and

(e) Cause the original notes to be stored at the FTA, as defined in

Sec. 120.600, and other loan documents to be stored with a third party

approved by SBA.

Sec. 120.425 What are the minimum elements that SBA will require

before consenting to a securitization?

A securitizer must comply with the following three conditions:

(a) Capital requirement.--All securitizers must maintain minimum

capital consistent with the requirements imposed on depository Lenders

by the bank regulatory agencies. For depository institutions, SBA will

consider compliance with the capital requirements of the bank

regulatory agencies as compliance with this section. SBA's capital

requirement does not change that which these banking agencies already

require. In addition to meeting the capital requirements of the bank

regulatory agencies, securitizing nondepository institutions also must

maintain a minimum unencumbered paid in capital and paid in surplus

equal to at least $1 million. Each nondepository institution must

submit annually audited financial statements demonstrating that it has

met SBA's capital requirement.

(b) Subordinated tranche.--A securitizer must retain a tranche of

the securities issued in the securitization (subordinated tranche)

equal to the greater of two times the securitizer's loss rate on the

securitizer's SBA loans, original and purchased, for a 10 year period

or 2 percent of the outstanding principal balance at the time of

securitization of the unguaranteed portions of the loans in the

securitization. This tranche must be subordinate to all other

securities issued in the securitization including other subordinated

tranches. The securitizer may not sell, pledge, transfer, assign, sell

participations in, or otherwise convey the subordinated tranche during

the first 6 years after the date of closing of the securitization. The

securities evidencing the subordinated tranche must bear a legend

stating that the securities may not be sold until 6 years after the

issue date. SBA may modify the formula for determining the tranche size

for a securitizer in a region affected by a severe economic downturn if

it concludes that enforcing this section might exacerbate the adverse

economic conditions in the region.

(c) PLP privilege suspension.--(1) If a PLP securitizer's currency

rate declines, SBA may suspend the securitizer's PLP unilateral loan

approval privileges (PLP approval privileges) under either of the

following circumstances:

(i) If the decline is more than 110% of the rate of the decline of

the currency rate of all loans approved under the PLP program (PLP

Program Loans) as calculated from quarter to quarter or

[[Page 27227]]

(ii) If the decline is more than five percentage points and the

currency rate of the PLP Program Loans remains stable or increases.

(2) SBA will calculate and compare the currency rate for PLP

Program Loans and the currency rate for each securitizer's portfolio

each quarter. Loans approved in the current fiscal year will not be

included in the calculation of the currency rate. In the event of a

severe downturn in a regional economy, a securitizer's currency rate is

adversely affected, SBA may waive privilege suspension for all

securitizers in the region, if it concludes that enforcing this section

might exacerbate the adverse economic conditions in the region.

Sec. 120.426 What action will SBA take if a securitizer transfers the

subordinated tranche prior to the termination of the holding period?

If a securitizer transfers the subordinated tranche prior to the

termination of the holding period, SBA immediately will suspend the

securitizer's ability to make new SBA loans. The securitizer will have

30 calendar days to submit an explanation to SBA. SBA will have 30

calendar days to review the explanation and determine whether or not to

lift the suspension. If an explanation is not received within 30

calendar days or the explanation is not satisfactory to SBA, SBA may

transfer the servicing of the applicable securitized loans, including

the securitizers' servicing fee on the guaranteed and unguaranteed

portions and the premium protection fee on the guaranteed portion, to

another SBA participating Lender.

Sec. 120.427 Will SBA approve a securitization application from a

capital impaired Lender?

If a Lender does not maintain the level of capital required by

Sec. 120.425(a), SBA will not approve a securitization application from

that Lender.

Sec. 120.428 What happens if SBA suspends a securitizer's PLP approval

privileges?

If SBA suspends a securitizer's PLP approval privileges:

(a) the securitizer must continue to service and liquidate loans

according to its PLP Supplemental Agreement.

(b) SBA may reinstate the securitizer's PLP approval privileges if

the securitizer demonstrates to SBA's satisfaction that the change in

currency rate was caused by factors beyond the securitizer's control.

4. Redesignate current Sec. 120.430 as Sec. 120.414.

5. Redesignate current Sec. 120.431 as Sec. 120.415.

6. Add Secs. 120.430 through 120.435 to read as follows:

Other Conveyances

Sec. 120.430 What conveyances are covered by Secs. 120-430 through

120.435?

Sections 120.430 through 120.435 cover all other transactions in

which a Lender sells, sells a participating interests in, or pledges an

SBA guaranteed loan other than for the purpose of securitizing and

other than conveyances covered under subpart F of this part.

Sec. 120.431 Which Lenders may sell, sell participations in, or pledge

SBA loans?

Notwithstanding the provisions of Section 120.453(c), all Lenders

may sell, sell participations in, or pledge SBA loans in accordance

with this subpart.

Sec. 120.432 Under what circumstances does this rule permit sales of,

or sales of participating interests in, SBA loans?

(a) A Lender may sell all of its interest in an SBA loan to another

Lender operating under a current Loan Guarantee Agreement (SBA Form

750) with SBA's prior written consent, which SBA may withhold in its

sole discretion. The purchasing Lender must take possession of the

promissory note and other loan documents and service the sold SBA loan.

The purchasing Lender must sign an agreement satisfactory to SBA

acknowledging that it is purchasing the loan subject to SBA's right to

deny liability on its guarantee.

(b) A Lender may sell, or sell a participating interest in, a part

of an SBA loan. If the Lender retains ownership of a part of the

unguaranteed portion of the loan equal to at least 10% of the

outstanding principal balance of the loan, the Lender must give SBA

prior written notice of the transaction, and the Lender must continue

to hold the note and service the loan. If a Lender retains ownership of

a portion of the unguaranteed interest of the loan equal to less than

10% of the outstanding principal balance of the loan, the Lender must

obtain SBA's prior written consent to the transaction, which consent

SBA may withhold in its sole discretion. The Lender must continue to

hold the note and service the loan unless otherwise agreed by SBA.

(c) For purposes of this section SBA will not consider a Lender to

be the owner of any portion of a loan in which it has sold a

participating interest.

Sec. 120.433 What are SBA's other requirements for sales and sales of

participating interests?

SBA requires the following:

(a) The Lender must be in good standing as determined by the AA/FA;

(b) In transactions requiring SBA's consent, all documentation must

be satisfactory to SBA, including, if SBA determines it to be

necessary, a multi-party agreement or other agreements satisfactory to

SBA; and

(c) The servicer of the loan or FTA must retain possession of the

original promissory notes. The servicer must retain possession of all

other original loan documents for all loans.

Sec. 120.434 What are SBA's requirements for loan pledges?

(a) Except as set forth in Section 120.435, SBA must give its prior

written consent to all pledges of any portion of an SBA loan, which

consent SBA may withhold in its sole discretion;

(b) The Lender must be in good standing as determined by the AA/FA;

(c) All loan documents must be satisfactory to SBA and must include

a multi-party agreement among SBA, Lender, the pledgee, FTA and such

other parties as SBA determines are necessary;

(d) The Lender must use the proceeds of the loan secured by the SBA

loans only for financing SBA loans;

(e) The Lender must remain the servicer of the loans and retain

possession of all loan documents other than the original promissory

notes; and

(f) The Lender must transfer the original promissory notes to FTA.

Sec. 120.435 Which loan pledges do not require notice to or consent by

SBA?

The following pledges of SBA loans do not require notice to or

consent by SBA:

(a) Treasury tax and loan accounts;

(b) The deposit of public funds;

(c) Uninvested trust funds;

(d) Discount borrowings at a Federal Reserve Bank; or

(e) Pledges to the Federal Home Loan Bank Board.

Dated: May 5, 1998.

Aida Alvarez,

Administrator.

[FR Doc. 98-12535 Filed 5-15-98; 8:45 am]

BILLING CODE 8025-01-P