[Federal Register Volume 64, Number 27 (Wednesday, February 10, 1999)]
[Rules and Regulations]
[Pages 6503-6510]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-3122]


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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



------------------------------------------------------------------------
                                                     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
------------------------------------------------------------------------
\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