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.

Proposed Rules Federal Register

27219

Vol. 63, No. 95

Monday, May 18, 1998

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Programs

AGENCY: Small Business Administration.

ACTION: Notice of proposed rulemaking

and public hearing.

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

§ 120.420, add §§ 110.421–120.429,

renumber §§ 120.430 and 120.431 as

§§ 120.414 and 120.415, and add

§§ 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
27220 Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules

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 longterm 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
Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules 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.
27222 Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules

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]

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

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
Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules 27223

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 empiricallybased 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.
27224 Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules

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

Year ending

Currency

rate

(percent)

Absolute

value of

change

Percentage

change

110% of

percent

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.

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
Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules 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 § 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 multiparty 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 § 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
27226 Federal Register / Vol. 63, No. 95 / Monday, May 18, 1998 / Proposed Rules

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 § 120.420 to read as follows:

Financings By Participating Lenders

§ 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 § 120.421 through 120.428 to

read as follows:

§ 120.421 Which Lenders may securitize?

All SBA participating Lenders may

securitize.

§ 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

§ 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.

§ 120.423 Which SBA loans may a Lender

securitize?

Notwithstanding the provisions of

§ 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.

§ 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

§ 120.600, and other loan documents to

be stored with a third party approved by

SBA.

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

§ 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.

§ 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 § 120.425(a),

SBA will not approve a securitization

application from that Lender.

§ 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 § 120.430 as

§ 120.414.

5. Redesignate current § 120.431 as

§ 120.415.

6. Add §§ 120.430 through 120.435 to

read as follows:

Other Conveyances

§ 120.430 What conveyances are covered

by §§ 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.

§ 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.

§ 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.

§ 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 multiparty 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.

§ 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.

§ 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