Business Loan Programs

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Programs

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: The U.S. Small Business Administration (SBA) is promulgating a

final rule to allow all participating Lenders to securitize the

unguaranteed portion of, sell, sell a participating interest in, or

pledge 7(a) loans. The rule 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 securitizations. In the second

component, SBA sets out rules to govern all pledges of, sales of a

participating interest in, and sales of, other than for the purpose of

securitizing, 7(a) loans. The components apply equally to all

depository and nondepository Lenders, leveling the playing field for

all SBA Lenders. Both components were drafted to protect the safety and

soundness of SBA's 7(a) loan program.

DATES: Effective Date: This rule is effective April 12, 1999.

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

Secondary Market Sales, (202) 205-6490.

SUPPLEMENTARY INFORMATION:

Background

SBA is promulgating a final rule to govern the securitization of

the unguaranteed portion of and the sale, sale of a participating

interest in, or pledge of 7(a) loans. The rule has two components. The

first component governs securitizations (``securitization component'').

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

sale of the unguaranteed portion of 7(a) 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 7(a) 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 7(a)

loans, together with interest.

The second component of this final rule governs pledges of, sales

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

of securitizing, 7(a) loans (``other conveyances'').

I. Securitization Component

Regulatory History

Congress and SBA have examined extensively whether and under what

conditions SBA should permit Lenders to securitize the unguaranteed

portion of 7(a) loans. Because Small Business Lending Companies

(``SBLCs''), Business and Industrial Development Companies (``BIDCOs'')

and other nondepository institutions (collectively the ``nondepository

Lenders'') do not have customer deposits to fund 7(a) lending, SBA, in

1992, permitted nondepository Lenders to securitize. Recognizing that

securitization may benefit all Lenders, in 1996, SBA and Congress

considered extending the securitization option to depository Lenders.

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

either promulgate regulations allowing both depository and

nondepository Lenders to securitize or cease approving any

securitizations.

Because securitization and, more particularly, securitization of

the unguaranteed portion of 7(a) loans is relatively new and involves

significant risk, SBA officials went to great lengths to fashion this

final rule responsibly. On November 29, 1996, SBA published the first

of a series of Federal Register notices designed to elicit public

participation in SBA's development of the securitization regulation (61

FR 60649). SBA hoped to receive comments to assist SBA to craft a

regulation allowing all Lenders to reap securitizations' benefits

without compromising the safety and soundness of the 7(a) program.

On February 26, 1997, SBA published its first proposed

securitization regulation (62 FR 8640). The proposed regulation

required all securitizations to include a 5 percent retention. SBA

received approximately 25 comments. The commenters were divided almost

equally on the proposal. Mindful of Congress' mandate to promulgate a

regulation or cease approving all securitizations, on April 2, 1997,

SBA promulgated an interim final rule (62 FR 15601) to govern

securitizations. The regulation allowed all SBA Lenders to securitize

while SBA continued its thorough review of securitization issues. Under

the interim final rule, SBA would review each proposed securitization

on a case-by-case basis for safety and soundness concerns.

Following SBA's promulgation of the proposed regulation, SBA held a

public hearing, met with banking experts, and consulted with bank

regulators from the Federal Deposit Insurance Corporation, the Office

of the Comptroller of the Currency, the Department of Treasury, the

Federal Reserve Board, the Office of Federal Housing Enterprise

Oversight, and the Office of Thrift Supervision (``bank regulators'').

SBA carefully considered the comments provided by the experts, the bank

regulators, and the industry before drafting another proposed

regulation. SBA tested the economics of the current proposal. A Big Six

accounting firm then validated all calculations.

On May 18, 1998, SBA published the current proposed securitization

regulation (63 FR 27219). It linked SBA securitization approval to a

securitizer's credit quality and incorporated incentives for

securitizers to safely securitize and service loans effectively. It

provided a three level unified regulatory approach to securitizations.

The three levels included: (1) a minimum capital requirement consistent

with that imposed by bank regulators; (2) a retention requirement in

the form of a subordinated tranche; and (3) a monitoring component

whereby a decline in a securitizer's Currency Rate (as defined in the

rule) would trigger PLP loan approval and securitization approval

suspension. The multi-faceted rule: (1) conditioned a securitizer's

ability to securitize on the securitizer's financial strength; (2) set

the required retention based on the individual securitizer's credit

quality history; and (3) invoked PLP benefits as an incentive for a

securitizer to continue underwriting and servicing loans properly. The

rule rewarded securitizers responsibly for past performance, current

performance, and future performance, measuring current performance

against past and that of the industry.

[[Page 6504]]

SBA encouraged feedback from experts, the industry, and the bank

regulators. On June 15, 1998, SBA held a public hearing to discuss the

current proposed regulation. SBA also received and reviewed

approximately 16 written comments. SBA has carefully considered the

oral and written comments, incorporating many recommendations into this

final rule.

Comments

Commenters generally applauded the current proposed securitization

rule (the ``proposed regulation''). Some stated that it ``encouraged

prudent credit quality management by Lenders'' and ``achiev[ed] the

Congressionally-mandated requirement of parity between depository and

nondepository Lenders.'' Commenters declared the proposed regulation a

substantial improvement over the February 1997 proposal, expressing

appreciation to SBA for carefully and deliberately rethinking its

earlier approach. The positive comments were accompanied by suggestions

to refine SBA's three level unified regulatory approach to

securitizations.

Capital Requirement

As stated in the proposed rule preamble, a capital requirement is a

basic component in regulating any financial institution. It is a common

method for measuring a Lender's financial strength. Requiring a

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. Eroding capital

is a measure of reduced financial strength and may signal weakening

credit quality.

SBA's proposed securitization regulation required ``all

securitizers * * * [to] maintain minimum capital consistent with the

requirements imposed on depository Lenders by the bank regulatory

agencies.'' For depository institutions, SBA would consider compliance

with the capital requirements of the bank regulatory agencies as

compliance with the regulation. The proposal also required that

nondepository institutions meet the capital requirements of the bank

regulatory agencies and, in addition, maintain minimum unencumbered

paid in capital and paid in surplus of at least $1 million.

SBA received some comments recommending that SBA clarify its

proposed capital requirement. Commenters pointed out that bank capital

requirements were complex and varied among regulators. In addition,

they noted that nondepository Lenders were not familiar with the

capital requirements of bank regulatory agencies. The commenters

suggested that SBA simplify its capital requirement for nondepository

institutions in the final rule. SBA agrees.

SBA also received comments recommending that SBA increase its

proposed capital level to 10 percent of a securitizer's unguaranteed

loan assets consistent with SBA's policy of reducing risk discussed in

the proposed rule. By requiring the slightly higher minimum capital

requirement, SBA limits securitization to financially strong Lenders.

It is these Lenders that will best be able to weather a downturn in the

economy, lessening SBA's exposure to risk. Finally, commenters

requested that SBA clarify that the capital charge applies not only to

the unguaranteed portion of the securitizer's 7(a) loans in the

portfolio but also to the remaining balance outstanding in the

securitization pools. SBA also agrees with both of these

recommendations and has incorporated them into the final rule.

The final rule provides that all securitizers must be considered to

be ``well capitalized'' by their regulator. SBA will consider a

depository institution to be in compliance with this section if it

meets the definition of ``well-capitalized'' used by its bank

regulator. SBA will consider a nondepository institution to be ``well

capitalized'' and have met this requirement if it maintains a minimum

unencumbered paid in capital and paid in surplus equal to at least 10

percent of its assets, excluding the guaranteed portion of its 7(a)

loans. SBA eliminated the $1 million minimum capital requirement for

nondepository institutions contained in the proposed regulation to make

the final rule more consistent between nondepository and depository

institutions.

The Subordinated Tranche

The second level of SBA's unified approach to regulating

securitizations is risk retention in the form of a subordinated

tranche. In the final rule, a securitizer must retain a tranche of the

securities in the securitization (``subordinated tranche'') equal to

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

securitizer's 7(a) loans disbursed for the preceding 10-year period or

2 percent of the principal balance outstanding at the time of

securitization of the unguaranteed portion of the loans in the

securitization. The Securitization Committee may modify the formula for

determining the tranche size for a securitizer creating a

securitization from a pool of loans located in a region affected by a

severe economic downturn if the Securitization Committee concludes that

enforcing this section might exacerbate the adverse economic conditions

in the region. SBA will monitor the initial retention level contained

in the final rule and, should economic conditions and policy

considerations warrant, SBA may modify the multiplier or minimum level

to protect the safety and soundness of the 7(a) program. SBA will

publish notice of any modification in the Federal Register and provide

an opportunity to comment.

Tying the required retention to a securitizer's historical

performance is fair and a common industry practice. It gives

securitizers a greater incentive to originate and service high quality

loans. The subordinated tranche would be subordinate to all other

tranches issued. SBA believes the minimum subordinated tranche is

necessary to counter the potential risks of securitizing elaborated in

the proposed rule's preamble.

Generally, commenters praised SBA's proposed tranche noting ``it

has great merit'' in that it: 1) ``ties benefits directly to

performance;'' and 2) is ``a credit enhancement tool.'' Commenters

recognized the importance of requiring an ``originating lender to

maintain an economic interest in [its] loan.'' Some praised the

subordinated tranche for offering flexibility to securitizers in their

``asset/liability management'' and as a ``fail safe'' to ``ensure that

even the top quality securitizers retain some measure of principal at

risk until the securitization matures.''

The comments SBA received addressing the details of the tranche

varied greatly. Many commenters supported the use of a loss-based

formula. Some suggested that SBA should decrease the loss multiple.

Others recommended that SBA increase required retention. SBA determined

to keep the proposed rule retention level, allowing for changes as

economic conditions and policy considerations warrant. Empirical

evidence supports the proposed rule retention level. Historical data

reveals that most securitizers' retention levels would fall between 12

and 2 percent. The average is expected to be approximately 5.4 percent.

SBA believes that this retention level is reasonable at this time. The

2 percent minimum also is reasonable at this time because it

approximates twice the cumulative loss rate of the best performing 7(a)

loan originators.

[[Page 6505]]

A few commenters suggested that SBA set retention at 2 percent of

the securitization plus any part of the securitization that does not

receive an investment grade rating. In addition, some commenters

suggested that SBA only approve a securitization if it contains no non-

investment grade securities. SBA believes that these requirements might

be too restrictive, as some securitizers have chosen to structure their

securitizations to include non-investment grade rated securities which

they may sell. As stated in the proposed rule preamble, SBA will not

rely solely on rating agencies to set retention levels.

Some commenters suggested that SBA shorten the 10-year ``look

back'' period. SBA has decided to retain the 10-year ``look back''

period because it considers the securitizer's loan performance over

several economic cycles. The 10-year ``look back'' period provides a

securitizer ample opportunity to demonstrate quality lending and

servicing without unduly penalizing the securitizer for cyclical

economic downturns.

At least one commenter recommended that SBA shorten the 6-year

holding period proposed in the rule. Conversely, other commenters

supported the 6-year holding period. The final rule includes the 6-year

holding period. SBA's historical loss data indicates that SBA Lenders

incur most losses between years three and five of a loan. 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. The holding period

reinforces the incentive to originate and service high quality loans.

PLP Loan Approval Suspension

In response to many comments, SBA has revised the formula

triggering PLP unilateral loan approval privilege suspension. The

proposed rule provided that ``[i]f 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: 1) If the decline is more than 110 percent 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 2) If the decline is more than five percentage points and

the currency rate for the PLP Program remains stable or increases. 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.''

Many commenters stated that the 110 percent benchmark was too

sensitive and that the five-percentage point benchmark was too large.

SBA agrees. Several commenters noted that the proposed rule failed to

consider cumulative deterioration in a securitizer's Currency Rate.

Others requested that securitizers that perform better than the SBA

portfolio should not be unduly penalized. To accommodate these

concerns, SBA modified the benchmark to provide greater flexibility to

securitizers.

The final rule provides that SBA will calculate an Initial Currency

Rate (``ICR'')--the securitizer's benchmark Currency Rate as of the end

of the calendar quarter immediately prior to the first securitization

completed after SBA promulgates these regulations, and an Initial

Currency Rate Percentage (``ICRP'')--the securitizer's Initial Currency

Rate compared to that of the SBA portfolio as of the end of the

calendar quarter immediately prior to the first securitization

completed after SBA promulgates these regulations. Each quarter, SBA

will compare each securitizer's Currency Rate to its ICR. If a

securitizer's Currency Rate on all of its 7(a) loans declines, SBA may

suspend the securitizer's PLP unilateral loan approval privileges (PLP

approval privileges) if: 1) the decline from the ICR is more than the

Benchmark Number as published in the Federal Register from time to

time; and 2) the securitizer's Currency Rate Percentage is less than

its ICRP.

The Benchmark Number referred to in the rule is the maximum number

of percentage points that a securitizer's Currency Rate can decrease

without triggering the PLP suspension provision contained in 13 CFR

120.425. The flexibility contained in the final rule is consistent with

the concept proposed in 13 CFR 120.425(c)(2). SBA will publish the

Benchmark Number in the Federal Register from time to time. SBA will

monitor the Benchmark Number and, if economic conditions or policy

considerations warrant, SBA may modify it to protect the safety and

soundness of the 7(a) program.

SBA will establish a Benchmark Number of 2.5 percentage points

initially. The 2.5 percentage points Benchmark Number was proposed by

some commenters. SBA considers a 2.5 percentage point decline in

Currency Rate a significant event warranting action. Some commenters

requested that SBA clarify the ``due process'' procedures in the PLP

suspension provision. Other commenters suggested that SBA incorporate

an intermediate step before suspending PLP approval privileges. SBA

agrees with both suggestions.

The final rule provides that a securitizer will first be placed on

probation for one quarter. At the end of the probationary quarter, if:

1) the securitizer has improved its Currency Rate to above its ICR less

the Benchmark Number; or 2) its Currency Rate Percentage is either the

same or greater than its ICRP, the probation will end. If at the end of

the probationary quarter, the securitizer has not met either condition

1 or 2, SBA will suspend the securitizer's PLP approval privileges and

will not approve additional securitization requests from that

securitizer. SBA will provide written notice at least 10 days prior to

the effective date of the suspension. The suspension will last a

minimum of three months. During the suspension period, the securitizer

must use Certified Lender or Regular Procedures to process 7(a) loan

applications.

The suspension will remain in effect until the securitizer meets

either condition 1 or 2 as discussed above. If the securitizer meets

either condition by the end of the 3-month period, notifies SBA with

acceptable documentation, and SBA agrees, SBA will reinstate the

securitizer. If the securitizer cannot meet either condition, the

suspension will remain in effect and the securitizer may then petition

the SBA Securitization Committee (to be formed after SBA publishes this

rule) for reinstatement. The Securitization Committee may consider the

economic conditions in the securitizer's market area, the securitizer's

efforts to improve its Currency Rate and the quality of the

securitizer's 7(a) loan packages and servicing. This language is

intended to replace the economic waiver provision in the proposed rule.

This provision was broadened in response to comments to allow the

Securitization Committee to consider additional factors warranting

waiver. The Securitization Committee will consider only one petition by

a securitizer per quarter. SBA will calculate Currency Rate and

Currency Rate Percentages quarterly from financial information

securitizers provide using SBA Form 1502.

By incorporating an ICR into the PLP formula, the formula takes

cumulative decline into account. SBA incorporated the ICRP ``safe-

harbor'' in response to the requests that securitizers who perform

better than the SBA portfolio should not be unduly penalized. SBA

[[Page 6506]]

believes the ICRP safe-harbor is fair and consistent with the proposed

rule's provision to monitor Currency Rate in relation to the SBA

portfolio. SBA does not want to preclude a securitizer's use of PLP

approval privileges if the securitizer's and the industry's portfolios

are both declining due to general economic conditions.

[GRAPHIC] [TIFF OMITTED] TR10FE99.000

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Percent Change

-------------------------------------------------------\1\--------\2\---

Year ending:

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

1981........................................... 77.70 2.50

1982........................................... 76.20 1.50

1983........................................... 75.50 0.70

1984........................................... 76.80 -1.30

1985........................................... 78.00 -1.20

1986........................................... 81.30 -3.30

1987........................................... 80.90 0.40

1988........................................... 83.50 -2.60

1989........................................... 84.70 -1.20

1990........................................... 86.90 -2.20

1991........................................... 86.20 0.70

1992........................................... 87.60 -1.40

1993........................................... 88.80 -1.20

1994........................................... 90.90 -2.10

1995........................................... 90.60 0.30

1996........................................... 89.40 1.20

Average Change............................... .......... 1.59

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\1\ SBA portfolio currency rate.

\2\ Value of year to year change.

Some commenters suggested that SBA adopt a numeric ``safe-harbor,''

such as a 95 percent Currency Rate. If the securitizer's Currency Rate

remained above the numeric safe harbor, the PLP suspension provision

would not be triggered. SBA chose not to select a numeric safe harbor.

Doing so might encourage good securitizers with a Currency Rate above

the safe harbor level to accept lower quality credits.

A few commenters suggested that SBA's quarterly review of Currency

Rates may be too short. After reviewing the matter, SBA reaffirmed its

decision to review Currency Rates quarterly. This third level of the

unified regulatory approach is intended to be an early warning trigger

to alert SBA and a securitizer of the securitizer's declining

performance. Ideally, SBA will be able to identify declining loan

performance before it can threaten a securitizer's entire portfolio and

financial condition. This monitoring may assist the securitizer to

improve credit practices while protecting the safety and soundness of

the 7(a) program.

Several commenters conveyed concern over SBA's ability to calculate

Currency Rates accurately. SBA, with the assistance of private sector

contractors, has overhauled its financial data management system. This

system will perform the Currency Rate calculations. Securitizers will

forward loan status data to SBA monthly. SBA will use this data to

calculate securitizers' Currency Rates. SBA will give securitizers the

opportunity to verify the calculations.

A few commenters suggested that the third level was unnecessary--

that SBA's PLP Reviews would uncover a securitizer's decline in credit

quality. PLP review and securitization Currency Rate tracking are two

separate, though complementary components, of SBA's overall Lender

oversight program. The PLP suspension provision is designed as an early

warning trigger to notify SBA and the securitizer of declining Currency

Rates and possible declining credit quality. SBA reviews all PLP

Lenders (approximately 500) annually. The PLP review is an in-depth

review geared to assess the long-term policy compliance and credit

quality of our PLP Lenders.

Finally, SBA received some requests to extend the securitization

regulation's PLP suspension provision to all PLP Lenders. At this time,

SBA declines to extend the provision. As elaborated in the proposed

rule preamble, SBA has imposed this level of protection in the

securitization regulation because securitization, in conjunction with

PLP approval privileges, magnifies risk to SBA. The PLP suspension

provision is

[[Page 6507]]

designed to serve as an incentive to securitizers to maintain or

improve their lending and sends a timely warning signal to SBA that a

securitizer's credit quality may be declining. If SBA were to extend

this to all PLP Lenders, it would require a separate rulemaking.

Additional Level

In the current proposed regulation, SBA requested comments and

suggestions for adding a fourth level to SBA's securitization

regulation. SBA envisioned that under a fourth level, SBA would monitor

a securitizer's loss rate after the securitization and assess a

supplemental payment against securitizers who experience long-term

performance declines. The fourth level would have provided securitizers

an additional incentive to maintain credit quality.

Many commenters rejected SBA's proposal for a fourth level

reasoning that the level, as discussed, could impair the securitizer,

force a compromise in servicing ability, and perhaps prevent the

securitization from receiving true sale treatment. Commenters further

opined that the market will exact sufficient penalties for deficient

portfolios. For these reasons, SBA has not added a fourth level to this

securitization regulation.

Additional Clarifications

One commenter recommended that SBA clarify its Currency Rate

definition. SBA has done so, clarifying that a securitizer's Currency

Rate is that of its entire 7(a) loan portfolio, not just PLP loans.

Using a securitizer's 7(a) loan portfolio as its Currency Rate baseline

measurement is a fair approach to monitoring a securitizer's

performance.

Two commenters suggested that SBA compute a securitizer's Loss Rate

and Currency Rate using the static curve rather than the pooling

method. SBA disagrees. SBA believes that the static curve method

introduces unnecessary complexity. SBA believes that any marginal

improvement to accuracy the static curve method may provide does not

justify the added complexity.

A few commenters requested that SBA reconsider its earlier position

to disallow securitized loan prefunding. SBA has reconsidered this

issue and will allow loans to be included in a securitization that are

closed within 90 days of the securitization.

Finally, SBA has always retained sole discretion to approve

securitizations within its regulatory framework. SBA does not intend

the regulatory framework in the final regulation to include every point

that SBA may consider in the future when evaluating a securitization

request. SBA recognizes that securitization methodologies and financial

markets are fluid. As securitization structures and financial markets

change, SBA may establish certain policies from time to time as part of

its securitization review which reflect the changes. For example, SBA

may establish a minimum Currency Rate that a securitizer must maintain

in order to securitize, SBA may require securitizers to maintain

additional capital for loans purchased from other lenders, and SBA may

establish requirements with respect to excess interest. SBA's intent in

allowing such policies to be established is to encourage securitization

for those Lenders that are financially strong and to 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.

Sales

This final rule requires that Lenders obtain SBA's prior written

consent for the sale of a Lender's entire interest in a loan to another

participating Lender. The final rule clarifies that SBA does not permit

sales to nonparticipating Lenders. The rule also requires that Lenders

obtain SBA's prior written consent to sales if the Lender will retain

less than 10 percent of the principal outstanding on the loan. However,

the rule requires only that Lenders provide written notice to SBA prior

to a sale after which the SBA Lender would continue to own a portion of

the unguaranteed interest equal to at least 10 percent of the

outstanding principal amount of the loan. The rules for sales of

participating interests mirror those for sales.

Pledges

This final rule also requires a Lender to obtain SBA's prior

written consent to all pledges of 7(a) loans except for certain types

of pledges enumerated in SBA's Loan Guaranty Agreement (SBA Form 750)

as amended from time to time and in 13 CFR 120.435. Except for such

enumerated pledges, the SBA Lender must use proceeds of the loan

secured by the 7(a) loans solely for the purpose of financing 7(a)

loans.

The final rule requires that a Lender be in good standing as

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

agreement, must be satisfactory to SBA. Finally, the final rule also

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

original promissory notes.

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 final rule does 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 final rule does 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

final rule replaces SBA's Interim Final Rule published on April 2,

1997. Like the Interim Final Rule, it allows depository Lenders to

securitize loans (as nondepository Lenders have done for the last six

years). Since the publication of SBA's Interim Final Rule, only a very

small number of depository Lenders have securitized. Moreover, those

Lenders do not qualify as small under SBA's size standards. 13 CFR

121.201.

SBA certifies that this final rule does 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

final rule has no federalism implications warranting preparation of a

Federalism Assessment.

For purposes of Executive Order 12778, SBA certifies that this

final rule has been drafted, to the extent practicable, to accord with

the standards set forth in section 2 of that Order.

List of Subjects in 13 CFR Part 120

Loan programs--business.

For the reasons set forth above, SBA amends 13 CFR part 120 as

follows:

PART 120--[AMENDED]

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

follows:

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

2. Revise the undesignated center heading immediately preceding

Sec. 120.420 to read as follows:

Participating Lender Financings

3. Revise Sec. 120.420 to read as follows:

Sec. 120.420 Definitions.

(a) 7(a) Loans--All references to 7(a) loans under this subpart

include loans

[[Page 6508]]

made under section 7(a) of the Small Business Act (15 U.S.C. 631 et

seq.) and loans made under section 502 of the Small Business Investment

Act (15 U.S.C. 661 et seq.), both of which may be securitized under

this subpart.

(b) 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.

(c) Benchmark Number--The maximum number of percentage points that

a securitizer's Currency Rate can decrease without triggering the PLP

suspension provision set forth in Sec. 120.425. SBA will publish the

Benchmark Number in the Federal Register.

(d) Currency Rate--A securitizer's ``Currency Rate'' is the dollar

balance of its 7(a) guaranteed loans that are less than 30 days past

due divided by the dollar balance of its portfolio of 7(a) guaranteed

loans outstanding, as calculated quarterly by SBA, excluding loans

approved in SBA's current fiscal year.

(e) Currency Rate Percentage--The relationship between the

securitizer's Currency Rate and the SBA 7(a) loan portfolio Currency

Rate as calculated by dividing the securitizer's Currency Rate by the

SBA 7(a) loan portfolio Currency Rate.

(f) Good Standing--A Lender is in ``good standing'' with SBA if it:

(1) Is in compliance with all applicable:

(i) Laws and regulations;

(ii) Policies; and

(iii) Procedures;

(2) Is in good financial condition as determined by SBA;

(3) Is not under investigation or indictment for, or has not been

convicted of, or had a judgment entered against it for a felony or

fraud, or charges relating to a breach of trust or violation of a law

or regulation protecting the integrity of business transactions or

relationships; and

(4) Does not have any officer or employee who has been under

investigation or indictment for, or has been convicted of, or had a

judgment entered against him for a felony or fraud, or charges relating

to a breach of trust or violation of a law or regulation protecting the

integrity of business transactions or relationships unless, the

Securitization Committee has determined that good standing exists

despite the existence of such person.

(g) Initial Currency Rate--The Initial Currency Rate (ICR) is the

securitizer's benchmark Currency Rate. SBA will calculate the

securitizer's ICR as of the end of the calendar quarter immediately

prior to the first securitization completed after April 12, 1999. This

calculation will include all 7(a) loans which are outstanding and were

approved in any fiscal year prior to SBA's current fiscal year. Each

quarter, SBA will compare each securitizer's Currency Rate to its ICR.

(h) Initial Currency Rate Percentage--The Initial Currency Rate

Percentage (ICRP) measures the relationship between a securitizer's

Initial Currency Rate and the SBA 7(a) loan portfolio Currency Rate at

the time of the first securitization after April 12, 1999. The ICRP is

calculated by dividing the securitizer's Currency Rate by the SBA 7(a)

loan portfolio Currency Rate. SBA will calculate the securitizer's ICRP

as of the end of the calendar quarter immediately prior to the first

securitization completed after April 12, 1999.

(i) Loss Rate--A securitizer's ``loss rate,'' as calculated by SBA,

is the aggregate principal amount of the securitizer's 7(a) loans

determined uncollectable by SBA for the most recent 10-year period,

excluding SBA's current fiscal year activity, divided by the aggregate

original principal amount of 7(a) loans disbursed by the securitizer

during that period.

(j) Nondepository Institution--A ``nondepository institution'' is a

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

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

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

(k) 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.

4. Add Secs. 120.421 through 120.428 to read as follows:

Sec. 120.421 Which Lenders may securitize?

All SBA participating Lenders may securitize subject to SBA's

approval.

Sec. 120.422 Are all securitizations subject to this subpart?

All securitizations are subject to this subpart. Until additional

regulations are promulgated, SBA will consider securitizations

involving multiple Lenders on a case by case basis, using the

conditions in Sec. 120.425 as a starting point. SBA will consider

securitizations by affiliates as single Lender securitizations for

purposes of this subpart.

Sec. 120.423 Which 7(a) loans may a Lender securitize?

A Lender may only securitize 7(a) loans that will be fully

disbursed within 90 days of the securitization's closing date. 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, as amended from time to time;

(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 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 be considered to be

``well capitalized'' by their regulator. SBA will consider a depository

institution to be in compliance with this section if it meets the

definition of ``well capitalized'' used by its bank regulator. SBA's

capital requirement does not change the requirements that banks already

meet. For nondepository institutions, SBA, as the regulator, will

consider a non-depository institution to be ``well capitalized'' if it

maintains a minimum unencumbered paid in capital and paid in surplus

equal to at least 10 percent of its assets, excluding the guaranteed

portion of 7(a) loans. Each nondepository institution must submit

annual audited financial statements demonstrating that it has met SBA's

capital requirement.

(b) Subordinated Tranche--A securitizer or its wholly owned

subsidiary 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 or 2 percent of the principal balance

outstanding at the time of securitization of the unguaranteed portion

of the loans in the securitization. This tranche must be subordinate to

all other securities issued

[[Page 6509]]

in the securitization including other subordinated tranches. The

securitizer or its wholly owned subsidiary may not sell, pledge,

transfer, assign, sell participations in, or otherwise convey the

subordinated tranche during the first 6 years after the closing date 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's Securitization Committee may modify

the formula for determining the tranche size for a securitizer creating

a securitization from a pool of loans located in a region affected by a

severe economic downturn if the Securitization Committee concludes that

enforcing this section might exacerbate the adverse economic conditions

in the region. SBA will work with the securitizer to verify the

accuracy of the data used to make the Loss Rate calculation.

(c) PLP Privilege Suspension.

(1) Suspension: If a securitizer's Currency Rate declines, SBA may

suspend the securitizer's PLP unilateral loan approval privileges (PLP

approval privileges) if the decline from the securitizer's ICR is more

than the Benchmark Number as published in the Federal Register from

time to time and the securitizer's Currency Rate Percentage is less

than its ICRP. The securitizer will first be placed on probation for

one quarter. If, at the end of the probationary quarter the securitizer

has not met either of the following conditions in paragraph (c)(1)(i)

or (c)(1)(ii) of this section, SBA will suspend the securitizer's PLP

approval privileges and will not approve additional securitization

requests from that securitizer. SBA will provide written notice at

least 10 days prior to the effective date of suspension. The suspension

will last a minimum of 3 months. During the suspension period, the

securitizer must use Certified Lender or Regular Procedures to process

7(a) loan applications. The prohibition will end if, at the end of the

probationary quarter: (i) the securitizer has improved its Currency

Rate to above its ICR less the Benchmark Number; or (ii) its Currency

Rate Percentage is either the same or greater than its ICRP.

(2) Reinstatement: The suspension will remain in effect until the

securitizer meets either the condition in paragraph (c)(1)(i) or

(c)(1)(ii) of this section. If the securitizer meets either condition

by the end of the 3-month period, notifies SBA with acceptable

documentation, and SBA agrees, SBA will reinstate the securitizer. If

the securitizer cannot meet either condition, the suspension will

remain in effect. The securitizer may then petition the SBA

Securitization Committee (Committee) for reinstatement. The Committee

will review the reinstatement petition and determine if the

securitizer's PLP approval privilege and securitization status should

be reinstated. The Committee may consider the economic conditions in

the securitizer's market area, the securitizer's efforts to improve its

Currency Rate, and the quality of the securitizer's 7(a) loan packages

and servicing. The Committee will consider only one petition by a

securitizer per quarter.

(3) The Benchmark Number. SBA will monitor the Benchmark Number. If

economic conditions or policy considerations warrant, SBA may modify

the Benchmark Number to protect the safety and soundness of the 7(a)

program.

(4) Data. SBA will calculate Currency Rate and Currency Rate

Percentages quarterly from financial information that securitizers

provide. SBA will work with a securitizer to verify the accuracy of the

data used to make the Currency Rate calculation.

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 will suspend immediately the

securitizer's ability to make new 7(a) loans. The securitizer will have

30 calendar days to submit an explanation to SBA's Securitization

Committee (``Committee''). The Committee will have 30 calendar days to

review the explanation and determine whether to lift the suspension. If

an explanation is not received within 30 calendar days or the

explanation is not satisfactory to the Committee, 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 Securitizer?

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

this subpart, SBA will not approve a securitization application from

that securitizer.

Sec. 120.428 What happens to a securitizer's other PLP

responsibilities if SBA suspends its PLP approval privilege?

The securitizer must continue to service and liquidate loans

according to its PLP Supplemental Agreement.

5. Redesignate current section 120.430 as section 120.414.

6. Revise the undesignated center heading immediately preceding

newly designated Sec. 120.414 to read MISCELLANEOUS PROVISIONS.

7. Redesignate current section 120.431 as section 120.415.

8. Add a new undesignated center heading and 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 interest in, or pledges an

SBA guaranteed loan other than for the purpose of securitizing and

other than conveyances covered under Subpart F, Secondary Market, of

this part.

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

7(a) loans?

All Lenders may sell, sell participations in, or pledge 7(a) loans

in accordance with this subpart.

Sec. 120.432 Under what circumstances does this subpart permit sales

of, or sales of participating interests in, 7(a) loans?

(a) A Lender may sell all of its interest in a 7(a) loan to another

Lender operating under a current Loan Guarantee Agreement (SBA Form

750) (``participating Lender''), with SBA's prior written consent,

which SBA may withhold in its sole discretion. A Lender may not sell

any of its interest in a 7(a) loan to a nonparticipating Lender. The

purchasing Lender must take possession of the promissory note and other

loan documents, and service the sold 7(a) loan. The purchasing Lender

purchases the loan subject to SBA's existing rights including its right

to deny liability on its guarantee as provided in Sec. 120.524. After

purchase, the purchased loan will be subject to the purchasing Lender's

Loan Guarantee Agreement.

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

of a 7(a) loan to another participating Lender. If the Lender retains

ownership of a part of the unguaranteed portion of the loan equal to at

least 10 percent 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 part of the unguaranteed portion of the loan

equal to less than 10 percent of the outstanding principal balance of

the loan, the Lender must obtain SBA's prior written consent to the

transaction,

[[Page 6510]]

which consent SBA may withhold in its sole discretion. The Lender must

continue to hold the note and other loan documents, and service the

loan unless SBA otherwise agrees in its sole discretion.

(c) For purposes of determining the percentage of ownership a

Lender has retained, SBA will not consider a Lender to be the owner of

the part 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;

and

(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.

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

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

written consent to all pledges of any portion of a 7(a) 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

7(a) loans only for financing 7(a) loans and for costs and expenses

directly connected with the borrowing for which the loans are pledged;

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

possession of all loan documents other than the original promissory

notes;

(f) The Lender must deposit the original promissory notes at the

FTA; and

(g) The Lender must retain an economic interest in and the ultimate

risk of loss on the unguaranteed portion of the loans.

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

SBA?

Notwithstanding the provisions of Sec. 120.434(d), 7(a) loans may

be pledged for the following purposes without 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) Advances by a Federal Home Loan Bank.

9. In Sec. 120.453 revise paragraphs (a) and (b) and remove

paragraph (c) to read as follows:

Sec. 120.453 What are the requirements of a PLP Lender in servicing

and liquidating SBA guaranteed loans?

* * * * *

(a) Take any action that confers a Preference on the Lender; and

(b) Accept a compromise settlement without prior written SBA

consent.

Dated: December 31, 1998.

Aida Alvarez,

Administrator.

[FR Doc. 99-3122 Filed 2-5-99; 9:29 am]

BILLING CODE 8025-01-P