[Federal Register Volume 62, Number 38 (Wednesday, February 26, 1997)]
[Proposed Rules]
[Pages 8640-8644]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-4785]
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SMALL BUSINESS ADMINISTRATION
13 CFR Part 120
Business Loan Programs
AGENCY: Small Business Administration.
ACTION: Proposed Rule.
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SUMMARY: The U. S. Small Business Administration (SBA) is proposing to
modify its rules regarding the financing and securitization of the
unguaranteed portion of loans guaranteed under Section 7(a) of the
Small Business Act. Present regulations provide these options only to
non-depository lenders. (13 CFR 120.420, Revised as of March 1, 1996)
These proposed rules would permit both depository and non-depository
lenders to pledge or securitize the unguaranteed portions of SBA
guaranteed loans.
DATES: Comments must be received March 28, 1997.
ADDRESSES: Comments may be mailed to Jane Palsgrove Butler, Acting
Associate
[[Page 8641]]
Administrator for Financial Assistance, U.S. Small Business
Administration, 409 Third Street, SW, Washington, DC 20416, Room 8200.
FOR FURTHER INFORMATION CONTACT: James W. Hammersley, Acting Deputy
Associate Administrator for Financial Assistance, (202) 205-7505.
SUPPLEMENTARY INFORMATION: Over the past several years, the average
SBA guaranty under its guaranteed business loan program (program) has
decreased from nearly 90% to approximately 75%. This 150% increase in
lender exposure requires lenders participating in the program to commit
substantially more of their own capital in order to support their
dollar volume of SBA guaranteed loans. In 1992, SBA promulgated
regulations that permitted non-depository lenders participating in the
program to pledge or securitize the unguaranteed portions of SBA
guaranteed loans, thereby permitting them to fund unguaranteed portions
of SBA guaranteed loans with the proceeds of loans and securities
offerings. (See 13 CFR Sec. 120.420, revised as of March 1, 1996.)
Since that time, bank (depository) participants have asked SBA to
modify its regulations to provide the same ability to them, in order to
offset the increase in commitment of capital needed to continue
participation in the program. Bankers have told SBA that, in many
cases, it is more efficient to raise funds through a pledge or
securitization than to attract additional deposits. Congress has now
recognized the need to permit all participants in the program to have a
level playing field in raising capital needed to fund the increased
requirement for unguaranteed portions. Therefore, recent legislation
prohibits any securitization under SBA's present regulations after
March 31, 1997, unless SBA develops regulations permitting all
participating lenders to pledge and securitize the unguaranteed
portions of their SBA guaranteed loans. See section 103(e) of Public
Law 104-408, Oct. 1, 1996, which directs SBA to promulgate a final
regulation ``that applies uniformly to both depository institutions and
other lenders * * * setting forth the terms and maintenance of
appropriate reserve requirements and other safeguards to protect the
safety and soundness of the program.''
I. Advance Notice of Proposed Rulemaking
On November 29, 1996, SBA published an advance notice of proposed
rulemaking which requested the views of interested parties on how this
statutory requirement might be satisfied. 61 FR 60,649, Nov. 29, 1996.
SBA received nine responses, including one response which had four
signatories. The comments corresponded to questions posed in the
Advance Notice Proposed Rulemaking. The following is a discussion of
the comments received.
Item one--How should lenders demonstrate a retained tangible
economic interest in a guaranteed loan? Should lenders be required to
retain an unguaranteed portion and/or a reserve? What level of
retention and/or reserve is adequate to protect the interest of SBA?
Each of the respondents provided comments on this item. One
suggested a 10% retention, one suggested a retention of 50% of the
unguaranteed portion of the loan and five suggested a retention of 5%
of the total amount of the loan. One respondent offered to work with
the Agency to develop a retention level appropriate to the credits and
one respondent proposed that a lender provide risk retention or supply
a credit enhancement of the lesser of (1) the level required to cause
all securities issued under the securitization transaction to third
parties to receive an investment grade rating, or (2) 5% of the total
outstanding principal of the loans which unguaranteed portion are
securitized.
Item two--Should we permit financing transactions on a periodic
scheduled basis or should lenders be permitted to submit transactions
whenever they want?
All of the respondents who commented on this item suggested that
there should not be a set schedule and that issuers should decide when
to take an issue to market.
Item three--Should we permit multiple lenders to ``pool''
transactions in one multi-party transaction? If so, how should this be
regulated?
Of the respondents who commented on this item, six were in favor
and one was against. Those in favor stated that pooling will be
necessary to make securitization available to small volume lenders. The
respondent opposing this idea suggested that multi-issuer pools would
allow lenders with poorer quality loans to spread their risk over a
larger number of loans.
Item four--Should we use third party resources to help process the
contemplated transactions? If so, what type of third parties? Who
should bear the costs associated with using third parties?
Only one respondent was against using third parties. This
respondent wants to keep the process as simple as possible and feels
that adding third parties will complicate the process. All others did
not object to using third parties as long as the fee for their services
was reasonable.
II. Background
In developing these proposed regulations, SBA attempted to balance
the needs of financial institutions, especially non-depository
financial institutions, to raise funds for operations with the mandate
that the program be operated on a safe and sound basis to protect the
interests of the taxpayers.
SBA has deliberated extensively over the issue of requiring a
retained economic interest in the loans. The Agency continues to
believe that the risk of loss to the originating lender has been the
cornerstone of the 7(a) loan program. For example, the Agency has
previously taken steps to reduce the premium received by lenders upon
the sale of the guaranteed portion of a loan when the Agency thought
that premiums had reached the level at which they may be reducing the
economic interest in the loans to the point that lenders would not be
cautious providers of credit.
In determining the proposed regulatory structure, the Agency also
tried to balance the ability of lenders to pledge the future income on
the loan with the need to maintain a level of safety for lenders. The
securitization structures used to date attempt to put the entire risk
of loss on the lender. In reviewing these structures, the Agency has
become concerned that there may not be a sufficient reserve available
for the entity to survive a modest increase in the historic loss rate.
One must remember that rating agencies involved in these transactions
are rating the security and the cash flows associated with it. They are
not making any type of determination as to whether the originator will
survive for the duration of the securitization.
Absent a securitization, a lender will have a guaranty on 75% of a
loan and have a 25% risk. If the unguaranteed portion of loans are
securitized, underwriters will require that the securitization be
structured so that investors are virtually protected from any loss. To
do this, securitizing lenders have had to pledge all of the cash flow
on the unguaranteed portion and a part of the cash flow on the
guaranteed portion that would otherwise be received by the lender.
Because the securitization does not change the risk of default on
loans, a lender is left in the position of assuming, in this example,
the entire risk associated with the 25% unguaranteed portion, but not
having
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the assets associated with that portion of the loan to offset its
securitization.
SBA has proposed regulations with these concerns in mind. Clearly,
it is not in SBA's interest to eliminate an avenue of funding used by
some of its lenders. Therefore, the Agency will review any final
regulations after a reasonable period of use and consider whether
changes are necessary based on experience with the structure that is
permitted.
III. Proposed Regulations
After having carefully considered all of these matters and the
responses to the advance notice, SBA is now proposing the following
regulations to satisfy the statutory requirement. The regulations being
proposed extend the coverage of the 1992 regulations to depository
lenders and propose a few changes in those regulations.
A. Technical Change
When SBA first considered securitization and pledging regulations
in 1992, it was confident that it had the resources to take over the
portfolio of a securitizing lender if the lender failed or defaulted on
its obligations under a securitization agreement. Since the
promulgation of those regulations, SBA has greatly decreased its staff.
The reduction of personnel has reduced SBA's ability to absorb
servicing and liquidation responsibilities for a large portfolio of
loans in the case of failure or default by a participating lender which
has securitized its unguaranteed portions. Therefore, as a condition to
the approval of any securitization of unguaranteed portions under the
1992 regulations, the Agency has required in securitization
documentation that a lender qualified to participate in the program,
and acceptable to SBA, identified as a back up servicer, will take over
the responsibilities required by SBA Form 750, ``Guaranty Loan
Agreement,'' for servicing and liquidation of loans made by a failed
participant. The proposed regulations incorporate this requirement.
Such servicing and liquidation must be performed under the terms of
SBA's Blanket Guaranty Agreement.
B. Extent of Securitization
SBA has had over three years to review the use of securitization by
non-depository participants. The Agency has decided that less than 100%
securitization of unguaranteed portions by lenders participating in the
program will provide them with enough capital to support adequate
levels of SBA guaranteed lending. Therefore, SBA is proposing to modify
its present regulations to require that participating lenders which
undertake securitizations retain the equivalent of at least a 5%
interest in each loan the unguaranteed portion of which is securitized.
In this regard, the proposed regulations are intended to provide a
level playing field for both depository and non-depository lenders to
securitize assets and ensure the safety and soundness of the program.
SBA intends to require that any securitizing lender demonstrate its
continuing economic interest in the securitized loans by one of the
following: (1) Retaining in its own portfolio unguaranteed portions
equal to 5% of the face value of all loans (guaranteed plus
unguaranteed portions) the unguaranteed portions of which are contained
in the securitization, (2) retaining a subordinate tranche equal to 5%
of the face value of all the loans the unguaranteed portions of which
are contained in the securitization, or (3) establishing a cash reserve
equal to 5% of the total face value of all of the loans the
unguaranteed portions of which are contained in the securitization.
Under any of the options, only the participating lender may regain use
of the proportional retained amount of funds after each corresponding
loan has been paid in full, or, in the case of a default, after the
collateral for the loan has been liquidated and a determination has
been made that there is no additional collectability.
If option (1) is used, the retained amount may be pledged as
collateral for a loan to fund the retainage. If option (3) is used, the
lender must establish the cash reserve at the time of the
securitization. The retainage in the case of option (3) must be held by
a custodian acceptable to SBA. In the event of a failure by the
securitizing lender, it must become available first to SBA to offset
expenses relative to servicing or liquidating the loans, and secondly,
to a subsequent servicer to be available for the same purposes.
C. Pledging
The 1992 regulations provided a method for non-depository lenders
to pledge the guaranteed and unguaranteed portions of their loans as a
means of financing the loans. The proposed regulations will extend the
same option to depository lenders. However under this regulation, all
lenders using a pledge agreement will be required to retain a cash flow
equal to 1% of the principal balance of any loan pledged if the
percentage of the loan pledged exceeds the unguaranteed percentage of
the loan. Thus, if a lender is pledging 100% of a portfolio of loans,
it must retain a cash flow equal to 1% of the principal balance of each
loan pledged. The documentation for the pledge must indicate that the
purpose of this holdback is to provide a sufficient reserve to pay the
cost of a new participating lender to take over servicing of pledged
loans in the event of the failure of the originating lender or its
default under the pledge agreement.
D. Capital Requirements
Presently under SBA's regulations, Small Business Lending Companies
(SBLCs), a subset of non-depository lenders, must maintain a minimum
private capital of $1,000,000 or 10% of the unguaranteed portions of
SBA guaranteed loans, whichever is more. (13 CFR 120.453) SBA is
proposing to continue the minimum capital requirement for SBLCs.
However, it is also proposing that SBLCs which securitize unguaranteed
portions and choose the option under these regulations either to retain
a percentage of the loans or a tranche of the securities must increase
their private capital by 8% of the unguaranteed portions retained or of
the tranche retained. This additional capital requirement will put
depository lenders and non-depository SBLC lenders in an equivalent
capital position with respect to SBA loans in which all or a part of
their unguaranteed portions are securitized. Thus, under this proposal,
an SBLC lender which retains a 5% tranche in a securitization, or
retains unguaranteed portions equal to 5% of the face amount of the
loans the unguaranteed portions of which are securitized must increase
its private capital by an amount equal to 8% of the retained tranche.
If the SBLC lender puts up a 5% cash reserve, the increase in capital
will not be necessary.
E. Custodial Agent
SBA is proposing that physical custody of the pertinent loan
documents relevant to pledging and securitizations be retained by the
SBA's fiscal and transfer agent (FTA) for the Section 7(a) loan
program, acting as custodian for the SBA and the parties to the
transaction. Although SBA has approved securitizations using other
entities as the custodian of the loan documents, the Agency is
concerned that increased securitization activity could make it
difficult for SBA to locate a particular borrower's note and collateral
documents if multiple custodians are permitted. Therefore, SBA is
proposing that the FTA handle this responsibility for all pledgings and
securitizations. The FTA already performs this service for several
existing transactions, and this requirement is not expected to have a
negative effect on the
[[Page 8643]]
ability of any lender to pledge or securitize unguaranteed portions of
loans.
Under the proposed regulations lenders which securitize will
continue to be bound by any other regulations and requirements that
otherwise apply to lenders making SBA loans. Thus, for example, should
a denial of liability on a guaranty or suit against a lender become
necessary, SBA will hold the lender or subsequent servicer, if
appropriate, responsible. The fact that unguaranteed portions of SBA
guaranteed loans have been sold to a trust for the purpose of a
securitization will not negate the requirements of SBA Form 750,
``Blanket Loan Guaranty Agreement,'' and SBA's regulations which
require the prudent servicing of SBA loans.
Compliance With Executive Orders 12612, 12778, and 12866, the
Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork
Reduction Act (44 U.S.C. Ch. 35).
SBA certifies that this proposed rule does constitute a significant
rule within the meaning of Executive Order 12866 but would not have a
significant economic impact on a substantial number of small entities
within the meaning of the Regulatory Flexibility Act, 5 U.S.C. 601 et
seq. We believe this rule is likely to have an annual economic effect
of $100 million or more, but we request comment from the public on its
perception of the costs and benefits associated with this rule to
enable SBA to prepare a cost benefit analysis in conjunction with the
final rule. It will not result in a major increase in costs or prices,
or have a significant adverse effect on competition or the United
States economy.
The proposed rule is consistent with the mandate of section 103(e)
of Public Law 104-208 which is to set forth terms and conditions under
which sales for the purpose of securitization can be permitted,
including the maintenance of appropriate reserve requirements and other
safeguards to protect the safety and soundness of the program. We
believe that the reserve requirements and other safeguards built into
the proposed regulations satisfy this concern. For the reasons set
forth above, we feel that the proposed regulations have the benefit of
permitting SBA's lenders to support an increased volume of SBA lending
without the outlay of the cost of unguaranteed portions. There are
reasonable alternatives involving retention of less or no reserve
requirement, but we do not believe that they are as likely to uphold
the safety and soundness of the program as are the proposed
regulations. Finally, the proposed regulations have no negative impact
on State, local, or tribal governments.
For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA
certifies that this final rule contains no new reporting or record
keeping requirements.
For purposes of Executive Order 12612, SBA certifies that this rule
has no federalism implications warranting the preparation of a
Federalism Assessment.
For purposes of Executive Order 12778, SBA certifies that this rule
is drafted, to the extent practicable, in accordance with the standards
set forth in section 2 of that Order.
List of Subjects in 13 CFR Part 120
Business loans.
For the reasons set forth above, SBA proposes to amend Part 120 of
title 13, Code of Federal Regulations, as follows:
PART 120--BUSINESS LOANS
1. The authority citation for 13 CFR part 120 continues to read as
follows:
Authority: 15 U.S.C. 634(b)(6) and 636(a) and (h).
2. Section 120.420 is revised to read as follows:
Sec. 120.420 Financings by participating lenders.
(a) A participating lender may pledge the notes evidencing SBA
guaranteed loans or sell interests in such notes representing the
unguaranteed portions of such loans if SBA, in its sole discretion,
gives its prior written consent. In order to obtain that consent, the
lender must be secure financially and have a history of compliance with
SBA's regulations and any other applicable state or Federal statutory
and regulatory requirements, and agree to the terms of these
regulations.
(b) A participating lender, SBA, and any third party involved in a
pledging or securitization transaction must enter into a written
agreement satisfactory to SBA in its sole discretion which acknowledges
SBA's interest as guarantor of the subject loans and in which all
relevant third parties agree to recognize and uphold those interests
under the Act, this part, and the contractual provisions of SBA's Loan
Guarantee Agreement. In any such agreement, the parties must agree to
the following conditions:
(1) Except in extremely unusual circumstances as determined by SBA
in its sole discretion, the fiscal and transfer agent for SBA will hold
all pertinent loan instruments as designated by SBA, and the lender
will continue to service the loans after the pledge or transfer is
made.
(2) It must be demonstrated to SBA's satisfaction that the lender
retains an economic risk in and bears the ultimate risk of loss on the
unguaranteed portions. In the case of a pledge of notes, the lender
must retain all of the economic interest in the unguaranteed portion of
any loan which a pledged note evidences. In the case of a sale of
unguaranteed portions of SBA guaranteed loans to support a
securitization, the lender must agree to either hold unguaranteed
portions equal to 5% of the total amount of the loans the remaining
unguaranteed portions of which are contained in the securitization, or
purchase or retain a subordinate tranche of the securitization equal to
5% of the total principal outstanding of the loans the unguaranteed
portions of which are contained in the securitization, or establish a
cash reserve of 5% of the face amount of the loans the unguaranteed
portions of which are contained in the securitization. Any cash reserve
retainage must be held in a bankruptcy remote environment, and in the
event of a default by the lender under the securitization agreement
shall become the property of SBA to be used first to cover SBA expenses
and losses, and secondly for payment of servicing and liquidating
expenses for the loans the unguaranteed portions of which are contained
the securitization. Any retainage covered in this paragraph shall be
proportionately decreased by the payment in full of each correspondent
loan or when the collateral for each correspondent loan has been fully
liquidated and a determination has been made that there is no
additional collectability.
(c) A lender which pledges notes must retain an income stream equal
to 1% of the face amount of any notes pledged if the percentage of the
corresponding loan pledged exceeds the unguaranteed percentage. The
fund must become the property of SBA in the event of a default by the
lender under the pledging agreement to be used first to cover SBA
expenses and losses, and secondly for payment to a backup servicer of
servicing and liquidating expenses for the loans pledged.
(d) Other than for the pledging against Treasury Loans and Tax
Accounts, a lender may not use SBA guaranteed loans or the collateral
supporting such loans as collateral for any borrowing not related to
financing of the guaranteed or unguaranteed portion of SBA loans.
(e) Any pledge or securitization agreement must identify a
successor servicer to the pledging or securitizing
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lender, agreeable to SBA which will be responsible for servicing and
liquidating loans in the case of default under the agreement by the
lender. A lender, or any successor servicer under a pledge or
securitization agreement, will be considered the lender of the loan
pledged or securitized under SBA rules, and will be bound by all
restrictions that otherwise apply to lenders making SBA loans as long
as either continues to act as servicer. SBA will hold the lender or
successor servicer responsible in the case of a denial of liability or
other adjustment to the amount of any SBA guaranty.
Sec. 120.470 [Amended]
3. Section 120.470(b)(3) is amended by adding the following
sentence at the end thereof:
* * * * *
(b) * * *
If pursuant to Section 420 of these regulations an SBLC sells the
unguaranteed portion of loans and retains either an amount of
unguaranteed portions equal to 5% of the total amount of the loans the
unguaranteed portions of which are contained in securitization, or a
subordinate tranche of a securitization equal to 5% of the face value
of the loans the unguaranteed portions of which are contained in the
securitization, it must increase its private capital by 8% of either
the face value of the unguaranteed portions of the loans retained or 8%
of the face value of the subordinate tranche.
Dated: February 12, 1997.
Ginger Ehn Lew,
Acting Administrator.
[FR Doc. 97-4785 Filed 2-25-97; 8:45 am]
BILLING CODE 8025-01-P
