[Federal Register Volume 80, Number 128 (Monday, July 6, 2015)]
[Notices]
[Pages 38499-38500]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-16430]


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SMALL BUSINESS ADMINISTRATION

[Docket ID No. SBA-2015-0009]


Small Business Investment Companies--Request for Comments on 
Credit and Risk Management Issues

AGENCY: U.S. Small Business Administration.

ACTION: Notice and request for comments.

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SUMMARY: The Small Business Administration (SBA) has identified two 
issues that potentially affect SBA's ability to make recoveries from a 
small business investment company (SBIC) that performs poorly and poses 
a credit risk to SBA. The Agency seeks public input on how SBA should 
address its credit concerns regarding these two issues: SBICs with 
unsecured lines of credit, and the determination of ``equity capital 
investments'' when calculating an SBIC's capital impairment percentage.

DATES: Comments must be received on or before September 4, 2015.

ADDRESSES: Submit your comments, identified by Docket ID No. SBA-2015-
0009, at www.regulations.gov. Comments may only be submitted at this 
web address; follow the instructions on the Web site for submitting 
comments. All comments received will be included in the public docket 
without change and will be available online at www.regulations.gov. All 
submissions, including attachments and other supporting materials, will 
become part of the public record and subject to public disclosure. 
Sensitive information and information that you consider to be 
Confidential Business Information or otherwise protected should not be 
included. Submissions will not be edited to remove any identifying or 
contact information.

FOR FURTHER INFORMATION CONTACT: Lyn Womack, Office of Investment and 
Innovation, 409 Third St. SW., Washington, DC 20416, (202) 205-2416.

SUPPLEMENTARY INFORMATION:

I. Background Information

    The SBIC Program was established under the Small Business 
Investment Act of 1958. 15 U.S.C. 661 et seq. (the ``Act''). SBICs are 
privately owned and professionally managed investment funds, licensed 
and regulated by SBA, that use privately-raised capital to make equity 
and debt investments in qualifying small businesses. SBICs may be 
leveraged or non-leveraged. Leveraged SBICs use privately raised 
capital plus funds borrowed by issuing debentures guaranteed by SBA to 
make such qualifying investments. Only SBICs with outstanding debenture 
leverage pose a credit risk to SBA, and SBA's request for input in this 
notice is limited to this type of SBIC. SBA does not anticipate any 
changes to the regulations as a result of this notice, but will 
consider changes to the policy guidance that interprets the 
regulations.
    SBICs are governed by Title 13, Part 107 in the Code of Federal 
Regulations (13 CFR part 107) which may be found at www.gpo.gov/fdsys/pkg/CFR-2014-title13-vol1/xml/CFR-2014-title13-vol1-part107.xml. SBA 
also issues supplemental guidance through various publications which 
may be found at www.sba.gov/sbicpolicy.

II. Areas of Concern

    SBA is seeking public input on the following areas of concern:
    1. Unsecured Lines of Credit. The Act provides that SBA ``(1) shall 
not permit a licensee having outstanding leverage to incur third party 
debt that would create or contribute to an unreasonable risk of default 
or loss to the Federal Government; and (2) shall permit such licensees 
to incur third party debt only on such terms and subject to such 
conditions as may be established by the Administrator, by regulation or 
otherwise.'' 15 U.S.C. 683(c). Pursuant to 13 CFR 107.550, a leveraged 
SBIC must obtain SBA's prior written approval before it incurs any 
secured third-party debt. In practice, SBA rarely approves secured 
third-party debt facilities because the collateral for such debt 
consists of the same assets SBA relies on to protect its creditor 
position. SBA approval is not required for unsecured third-party debt, 
though the Agency may review the related loan agreement(s) in 
connection with its oversight, including examinations, of the SBIC.
    Leveraged SBICs commonly use unsecured lines of credit. Although 
permitted by the regulations without SBA prior approval, all such 
credit facilities pose a potential credit risk to SBA because, with 
certain limited exceptions set forth under 13 CFR 107.560, the Agency 
is subordinated to the first $10 million of such debt. Furthermore, SBA 
is concerned that many such credit facilities contain certain 
provisions that may increase SBA's credit risk. SBA is specifically 
concerned about provisions that, upon a default (which may include 
events other than a payment default; for example, failure by more than 
a certain number of investors in the SBIC to fund a capital call within 
a stated period), allow a lender to make a capital call directly on the 
SBIC's investors and use the proceeds to repay the line of credit. 
Similarly, SBA is concerned about provisions that permit a lender to 
compel the SBIC's General Partner to make a capital call, together with 
remedies including specific performance and/or injunctive relief. If an 
SBIC defaults on its leverage and is transferred by SBA to a 
liquidation status in accordance with the SBIC's leverage terms, the 
SBIC's remaining commitments are a significant source of capital that 
SBA relies upon for repayment of the SBIC's leverage. However, such 
commitments will not be available to SBA if they have already been 
called to satisfy a default under the SBIC's unsecured credit facility. 
SBA has also observed that some SBICs use these lines on a short-term 
basis to fund investments, while others maintain outstanding balances 
on a longer-term basis for working capital or other purposes.
    SBA is seeking comments as to how the Agency can best address its 
credit concerns while continuing to permit SBICs to utilize unsecured 
lines of credit. Among other things, SBA is seeking input from the 
public with regard to the following questions:
    (a) What credit concerns should SBA have regarding an SBIC's credit 
facility if the maximum extension of credit under such a facility is in 
the amount of $10 million or less?
    (b) How frequently, or what percent of total dollars or lines of 
credit, do lenders provide unsecured credit to SBICs in an amount above 
$10 million?
    (c) What are the typical maturity dates for such credit facilities 
(e.g., 12 month term) and are they routinely extended?

[[Page 38500]]

    (d) What is the average balance and settlement of credit lines 
extended to SBICs?
    (e) Based on SBA's view that short-term borrowings pose a lower 
credit risk, what restrictions, if any, should SBA consider placing on 
the length of time a balance may remain outstanding on an unsecured 
line?
    (f) Should SBA permit such facilities only during time periods of 
an SBIC's lifecycle when the risk to SBA is lower, for example during 
the early years of the SBIC's life or before additional leverage is 
drawn? If so, what considerations should SBA take into account in 
determining the timing and duration of these periods?
    (g) Are there certain provisions in unsecured loan agreements that 
SBA should be especially concerned about with respect to credit risk 
(e.g., remedies available to a lender such as specific performance or 
injunctive relief) and how should SBA deal with those provisions?
    (h) What type of credit risk policies would be most effective in 
managing SBA's credit risk with respect to unsecured lines of credit?
    2. Determination of Equity Capital Investments (ECI) in the 
calculation of an SBIC's maximum allowable Capital Impairment 
Percentage (CIP). 13 CFR 107.1830(c) defines the maximum allowable CIP 
for a leveraged SBIC that is not an Early Stage SBIC. If an SBIC 
exceeds its maximum allowable CIP, it constitutes a condition of 
Capital Impairment, which is an event of default under the terms of its 
leverage. 13 CFR 107.1810(f)(5). An SBIC's maximum allowable CIP 
depends on two variables: (1) the percentage at cost of ECI in the 
SBIC's portfolio, and (2) the ratio of outstanding leverage to 
Leverageable Capital.
    Under 13 CFR 107.50, ECI generally means investments in a small 
business in the form of common or preferred stock, limited partnership 
interests, options, warrants, or similar equity instruments, including 
subordinated debt with equity features if such debt provides only for 
interest payments contingent upon and limited to the extent of 
earnings. Further, Leverageable Capital means, as more fully described 
in 13 CFR 107.50, paid-in capital of an SBIC.
    SBA's regulations permit a higher maximum allowable CIP when the 
percentage of ECI in an SBIC's portfolio is higher in recognition that 
equity-type investment strategies are inherently riskier and frequently 
require a longer holding period relative to debt investments before a 
successful exit can be achieved.
    SBA has observed over the last few years that SBICs seeking to 
avoid Capital Impairment have converted non-ECI investments to ECI 
solely for the purpose of attaining an increase in maximum allowable 
CIP. For example, an SBIC can convert a loan into equity, which would 
cause the investment to then qualify as ECI. Depending on the 
circumstances of the SBIC, the converted security could cause the 
SBIC's maximum allowable CIP to increase and artificially forestall the 
SBIC from having a condition of Capital Impairment, which creates risk 
to taxpayers.
    SBA has also observed the deteriorating performance of portfolio 
companies held in a particular SBIC can likewise result in an SBIC's 
maximum allowable CIP increasing. Using the example in the prior 
paragraph, the loan could have been converted to equity as a result of 
a distressed restructuring of the company. In either case, the 
increased ECI was not the result of the SBIC making an ECI investment 
from the outset, but instead converting non-ECI based on the impairment 
status of the SBIC or the deteriorated status of a small concern.
    SBA aims to prevent conversions specifically and solely intended to 
artificially increase maximum allowable CIP, because such conversions 
result in the SBIC having a reduced collateral position in the 
portfolio company at a time when that collateral may be critical for 
SBA to obtain a recovery from the SBIC. However, in considering any 
policy changes to managing its credit risk with respect to ECI, SBA 
does not seek to create unnecessary burdens for SBICs who may convert 
an investment to ECI for business reasons unrelated to solely avoiding 
Capital Impairment (e.g., the exercise of conversion rights prior to a 
planned IPO). Accordingly, the Agency welcomes comments from the public 
on how to achieve this objective. Comments may be general in nature 
and/or answer the following questions:
    (a) Other than the examples provided in this notice, what 
transactions or circumstances can result in an original non-ECI 
becoming qualified as an ECI?
    (b) What specific factors should SBA consider in determining that 
investments are disqualified as ECI for the purposes of calculating an 
SBIC's maximum allowable CIP?
    (c) Without creating an undue reporting burden on SBICs, how can 
SBA differentiate between investments converted for legitimate business 
reasons and those converted for other reasons, including solely to 
inflate total ECI in the SBIC's portfolio?

    Authority: 15 U.S.C. 681.

Javier Saade,
Associate Administrator for Investment and Innovation.
[FR Doc. 2015-16430 Filed 7-2-15; 8:45 am]
 BILLING CODE 8025-01-P