[Federal Register Volume 63, Number 95 (Monday, May 18, 1998)]
[Proposed Rules]
[Pages 27219-27227]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-12535]


 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
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 

  Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed 
Rules  

[[Page 27219]]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120


Business Loan Programs

AGENCY: Small Business Administration.

ACTION: Notice of proposed rulemaking and public hearing.

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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]                                                                                          
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                      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
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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
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[[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                                                    
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                                                                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