SBA Lender Risk Rating System Notice and Request for Comments

SUMMARY:

SBA is proposing for comment a lender risk rating system. The lender risk rating system is an internal tool to assist SBA in assessing the risk of each active 7(a) Lender and Certified Development Company's (“SBA Lender”) SBA loan operations, and loan portfolio, on a uniform basis and for identifying those institutions whose SBA loan operations and portfolio require additional SBA monitoring or other action. It is also a vehicle for assessing the aggregate strength of SBA's 7(a) and 504 portfolios. Under the lender risk rating system, SBA would assign each Lender a composite rating based on certain portfolio performance factors, which may be overridden in some cases due to Lender specific factors that may be indicative of a higher or lower level of risk. SBA Lenders would have access to their own ratings through SBA's Lender Portal.

DATES:

SBA must receive comments on or before June 15, 2006.

ADDRESSES:

You may submit comments by any of the following methods (1) E-mail proposedriskrating@sba.gov; (2) Fax: (202) 205-6831; (3) Mail: John M. White, Deputy Associate Administrator, Office of Lender Oversight, U.S. Small Business Administration, 409 Third Street, SW., Washington, DC 20416; (4) Hand Delivery/Courier: 409 Third Street, SW., Washington, DC 20416, c/o John M. White.

FOR FURTHER INFORMATION CONTACT:

John M. White, Deputy Associate Administrator, Office of Lender Oversight, U.S. Small Business Administration, 409 Third Street, SW., Washington, DC 20416, (202) 205-3049.

SUPPLEMENTARY INFORMATION:

Background

SBA is developing an internal risk rating system for assessing an SBA Lender's 7(a) or 504 loan portfolio (i.e., loan portfolio performance). The risk rating system will be an internal tool that will assist SBA in assessing the risk of a Lender's 7(a) and 504 loan performance on a uniform basis and identify those Lenders whose portfolio performance demonstrates the need for additional SBA monitoring or other action. It is not intended to be a Lender grading system. The lender risk rating system will also serve as a vehicle to measure the aggregate strength of SBA's overall 7(a) and 504 loan portfolios and to assist SBA in managing the related risk. SBA will use Lender risk ratings to make more effective use of its on-site and off-site lender review and assessments resources. The proposed risk rating methodology is set forth below. SBA is soliciting comments on the risk rating methodology. During the comment period, SBA will provide Lenders access to their own preliminary risk ratings through SBA's Lender Portal. A more detailed discussion of the risk rating proposal and portal access follows.

Risk Rating Proposal

Overview

Under SBA's proposed risk rating system, SBA would assign all Lenders a composite rating. The composite rating would reflect SBA's assessment of the potential risk to the government of that Lender's SBA portfolio performance.

For 7(a) Lenders, SBA would base the composite rating on four common components or factors. The common factors for 7(a) Lenders would be as follows: (i) 12 month actual purchase rate; (ii) problem loan rate; (iii) three month change in the small business predictive score (SBPS), which is a small business credit score on loans in the 7(a) Lender's portfolio; and (iv) projected purchase rate derived from the SBPS.

For CDCs, SBA would base the composite rating on three common components or factors. The common factors for CDCs would be as follows: (i) 12 month actual purchase rate; (ii) problem loan rate; and (iii) average SBPS on loans in the 504 Lender's portfolio. The third factor replaces the third and fourth factors used for 7(a) Lenders because it was found, during the testing process, to be more predictive of SBA purchases for 504 Lenders.

In general, these factors reflect both historical lender performance and projected future performance. The factors are derived through formulas developed using regression analysis validated and tested by industry experts. SBA would perform quarterly calculations on the common factors for each Lender, so that Lenders' composite risk ratings would be updated on a quarterly basis. Each of the factors is described in more detail in the Rating Components section below.

The composite risk rating is a measure of how each Lender's loan performance compares to the loan performance of its peers. Thus, an individual Lender's overall loan performance (using all common factors) would be compared to its peers to derive that Lender's composite risk rating. Lenders whose overall portfolio performance (using all of the common factors) is worse than their peers will receive a worse, or higher score, while Lenders whose overall portfolio performance is better than their peers will receive a better, or lower, score.

SBA recognizes that it may be inequitable to compare all Lenders in a risk rating system, without separating them into peer groups, because changes in loan performance would have dramatically different impacts on the portfolio performance of Lenders of different sizes. For example, the purchase of one loan from a Lender would have a much higher impact on the actual purchase rate component of a Lender with a small portfolio than it would on the actual purchase rate of a Lender with a large portfolio. Therefore, SBA has established peer groups to minimize the differences that could result from changes in loan performance for portfolios of different sizes. The peer groups are as follows (based on outstanding SBA guaranteed dollars):

As noted above, the common components would be used to derive a composite risk rating for each 7(a) and 504 Lender. Under the proposal, no single component factor would normally decide the Lender's composite rating. However, depending upon the size of the peer group, and the variation between a Lender's performance and that of its peers, a single factor could carry a disproportionate weight among the three or four components.

Composite Rating

SBA would assign a composite rating of 1 to 5 to each Lender based upon their portfolio performance. A rating of 1 would indicate strong portfolio performance, least risk, and the least degree of SBA management oversight is needed (relative to other Lenders in their peer group), while a 5 rating would indicate weak portfolio performance, highest risk, and therefore, the highest degree of SBA management oversight. SBA proposes the following definitions for the composite ratings.

Composite 1—The SBA operations of a Lender rated 1 would be considered strong in every respect, and would likely score much better than SBA averages in all or nearly all of the rating components described in this notice. A Lender rated 1 would have relatively stable component factors and overall composite rating from one quarter to the next. Since the component factors measure previous performance, and also attempt to predict future performance, a Lender rated 1 would be more likely to have well below average historical purchase rates, as well as well below average current problem loan rates that would predict lower than average future purchase rates. Overall, loans in the portfolio of a Lender rated 1 would demonstrate highly acceptable credit quality and/or credit trends as measured by credit scores and portfolio performance. A Lender rated 1 would typically also have a well managed SBA loan program as demonstrated through on-site or off-site reviews and assessments (of mid-size and larger Lenders). Based on the strengths outlined in this composite rating, Lenders rated a 1 would present SBA with the least amount of risk, and would thus be subject to the lowest level of SBA oversight compared to other Lenders in the same peer group.

Composite 2—The SBA operations of a Lender rated 2 would be considered good, and would likely be above average in all or nearly all of the rating components described in this notice. A Lender rated a 2 would have component factors and a composite rating that would typically be relatively stable from one quarter to the next. A Lender rated 2 would be more likely to have below average previous (historical) purchase rates, as well as below average current problem loan rates that would predict lower than average future purchase rates. Generally, loans in the portfolio of a Lender rated 2 would demonstrate better-than-acceptable credit quality and/or credit trends as measured by credit scores and portfolio performance. A Lender rated 2 would likely have a generally well managed (i.e., a few minor exceptions or findings) SBA loan program as demonstrated through on-site or off-site reviews and assessments (of mid-size and large Lenders). Based on the strengths outlined in this composite rating. Lenders rated a 2 would present SBA with a lower level of risk, and would thus be subject to a lower level of SBA oversight compared to other Lenders in the same peer groups.

Composite 3—The SBA operations of a Lender rated 3 would be considered about average in all or nearly all of the rating components described in this notice. A Lender rated a 3 would have, on average, component factors and an overall composite rating that would generally be relatively stable from one quarter to the next. A Lender rated 3 would likely have average previous (historical) purchase rates (as compared to their peers), as well as average current problem loans rates that would predict future purchase rates in line with SBA portfolio averages. Generally, loans in the portfolio of a Lender rated 3 would demonstrate acceptable credit quality and/or credit trends as measured by credit scores and portfolio performance. A Lender rated 3 would have an adequate (i.e., some minor exceptions or findings, but few if any major exceptions or findings, which can be corrected in the normal course of business) SBA loan program as demonstrated through on-site or off-site reviews and assessments (of mid-size and large Lenders). However, Lenders rated a 3 would have room for improvement, should monitor their portfolio closely, and consider methods to improve loan performance. Based on the strengths and weaknesses outlined in this composite rating, Lenders rated a 3 would present SBA with an acceptable level of risk, and would thus be subject to standard SBA oversight compared to other Lenders in the same peer group. Oversight may include requests for corrective action plans.

Composite 4—The SBA operations of Lender rated 4 would be considered below average in all or nearly all of the rating components described in this notice. A Lender rated a 4 may have several changes in any of its components factor rates; the component factors and overall composite rating may demonstrate instability or negative performance from one quarter to the next. A Lender rated 4 would be likely have above average previous (historical) purchase rates (as compared to their peers), as well as above average current problem loan rates that would predict future purchase rates above SBA portfolio averages. Generally, loans in the portfolio of a Lender rated 4 would demonstrate somewhat less-than-acceptable credit quality and/or credit trends as measured by credit scores and portfolio performance. A lender rated 4 would likely have a poorly managed (i.e., both minor exceptions or findings, and major exceptions or findings) SBA loan program as demonstrated through on-site or off-site reviews and assessments (of mid-size and large Lenders). Based on the weaknesses outlined in this composite rating, Lenders rated a 4 would present SBA with a less-than-acceptable level of risk, and would thus be subject to greater than normal SBA oversight compared to other Lenders in the same peer group. Oversight measures could include (but are not limited to) additional reviews or assessments, requests for corrective action plans, and/or removal from delegated loan programs, depending upon the level of activity and peer group.

Composite 5—The SBA operations of a Lender rated 5 would be considered well below average in all or nearly all of the rating components described in this notice. A Lender rated a 5 is most likely to have changes in any of its component factor rates, and have the greatest likelihood to have their component factors and overall composite rating demonstrate instability or negative performance from one quarter to the next. A Lender rated 5 would be probably have well above average previous (historical) purchase rates, as well as well above average current problem loan rates that would predict future purchase rates above SBA portfolio averages. Generally, loans in the portfolio of a Lender rated 5 would demonstrate less-than-acceptable credit quality and/or credit trends as measured by credit scores and portfolio performance. A Lender rated 5 would likely have a record of significant SBA program compliance issues as demonstrated through on-site or off-site reviews and assessments (of mid-size and large Lenders). Based on the substantial weaknesses outlined in this composite rating, Lenders rated a 5 would present SBA with the highest level of risk, and would thus be subject to extensive SBA oversight compared to other Lenders in the same peer group. Oversight measures could include (but are not limited to) additional reviews or assessments, requests for corrective action plans, and and/or removal from delegated loan programs, depending upon the level of activity and peer group.

The descriptions within each Composite rating are not meant as definitions of the ratings, but are given to provide, in general, the characteristics a Lender receiving a particular rating may exhibit. Consequently, a Lender assigned a particular composite rating may not exhibit every characteristic described for that rating, nor would SBA's action be limited to those stated in the descriptions.

In some cases, SBA may have reason to believe that a Lender's calculated composite rating may not fully reflect the level of risk that individual Lender presents. In those cases, SBA may override the composite risk rating (either positively or negatively) and assign a different composite score. Should a decision be made to override the composite score, SBA will provide the Lender with an explanation of the reason(s) for the override. More information on overrides of composite ratings is provided in the overriding factors section of this notice.

SBA's proposal to base composite ratings on a numeric scale is similar to rating systems used by bank regulators and other federal loan guarantors. For example, SBA's composite rating of 1 is similar to that of a bank regulator in that it is indicative of an institution with strong performance and requiring little management oversight. SBA's rating system is similar to those of other federal loan guarantors because it measures risk and portfolio performance of loan portfolios guaranteed by SBA, rather than measuring the quality of the entire institution.

Rating Components

The 4 Common Components for 7(a) Lenders:

SBA's proposed quantitative risk rating system for 7(a) Lenders features four common component factors. The four common rating components are defined below.

(i) Past 12 Month Actual Purchase Rate—The Past 12 Month Actual Purchase Rate is an historical measure of SBA purchases from the Lender in the preceding 12 months. Thus, this component provides a measure of Lender performance and risk as indicated by actual SBA purchases. SBA calculates this ratio by dividing the sum of total gross dollars of the Lender's loans purchased during the past 12 months (numerator) by the sum of total gross outstanding dollars of their SBA loans outstanding at the end of the 12-month period, plus gross dollars purchased during the past 12 months (denominator).

(ii) Problem Loan Rate—The Problem Loan Rate provides an indication of current Lender risk. This problem loan indicator helps measure Lender performance and risk by showing current delinquencies and liquidations, as well as predicting potential future purchases by SBA. SBA calculates the problem loan rate by dividing total gross outstanding dollars of a Lender's loans that are 90 days or more delinquent plus gross dollars in liquidation, excluding purchases of active loans, (numerator) by the total gross dollars outstanding (denominator).

(iii) 3 Month Change in Small Business Predictive Scores (SBPS)—The SBPS is a portfolio management (not origination) credit score based upon a borrower's business credit report and principal's consumer credit report. SBPS is a proprietary calculation provided by Dunn & Bradstreet, under contract with SBA, and is compatible with Fair, Isaac & Co.'s “Liquid Credit” origination score. This component signals increasing or declining purchase risk by measuring changes in borrower credit trends, and acts as a predictor of possible future loan delinquencies, liquidations, and SBA purchases. The 3 month change in SBPS is calculated by measuring the percentage change, on a dollar-weighted average basis, of the SBPS on all outstanding SBA loans held by the lender, from the previous quarter to the current quarter.

(iv) Projected Purchase Rate—The Projected Purchase Rate is a predictive measure of the probability of the amount of SBA guaranteed dollars in a Lender's portfolio that are likely to be purchased by SBA. This factor uses credit bureau data on a Lender's individual SBA loans to project the purchase rate of a Lender's SBA portfolio. It is a 12-month projection of future performance based on the most current credit data on a borrower's payment history. For each of a Lender's SBA loans outstanding, SBA multiplies the amount of guaranteed loan dollars outstanding by the probability of its purchase (as determined by the SBPS of the individual loan) and totals the sum of each individual loan outstanding. This total (numerator) is then divided by the Lender's total SBA-guaranteed dollars outstanding (denominator).

The 3 Common Components for CDCs:

SBA's proposed quantitative risk rating system for 504 Lenders features three common component factors. The three common rating components are defined below.

(i) Past 12 Month Actual Purchase Rate—The Past 12 Month Actual Purchase Rate is an historical measure of SBA purchases from the CDC in the preceding 12 months. Thus, this component provides a measure of CDC performance and risk as indicated by actual SBA purchases. SBA calculates this ratio by dividing the sum of total SBA gross dollars of the CDC's loans purchased during the past 12 months (numerator) by the sum of total SBA gross dollars of their SBA loans outstanding at the end of the 12-month period, plus total SBA gross dollars purchased during the past 12 months (denominator).

(ii) Problem Loan Rate—The Problem Loan Rate provides an indication of current CDC risk. This problem loan indicator helps measure CDC performance and risk by showing current delinquencies and liquidations, as well as predicting potential future purchases by SBA. SBA calculates the problem loan rate by dividing the total SBA gross dollars of a CDC's loans that are 90 days or more delinquent plus total SBA gross dollars of a CDC's loans in liquidation (numerator), by the total SBA gross dollars outstanding (denominator).

(iii) Average Small Business Predictive Scores (SBPS)—The SBPS is a portfolio management (not origination) credit score based upon a borrower's business credit report and principal's consumer credit report. SBPS is a proprietary calculation provided by Dunn & Bradstreet, under contract with SBA, and is compatible with Fair, Isaac & Co.'s “Liquid Credit” origination score. This component provides an indication of the relative credit quality of the loans in a CDC's SBA portfolio. The score is calculated from the average SBPS score of the loans in a CDC's portfolio, weighted by each loan's guaranteed loan dollars outstanding.

Each of the common components described above would reflect a different means of measuring a Lender's risk to SBA in terms of loan purchase data. Loan purchase metrics provide a core gauge of SBA lending success and program risk. SBA believes a risk rating system emphasizing purchase indicators would be a good measure of SBA lending risk because purchases are a strong indicator of the cost to SBA, and predictive of final charge offs and loan recoveries. In addition, loan purchases are resource intensive and an administrative expense to SBA that reduces SBA's ability to provide assistance to small businesses. Finally, SBA is a “gap” lender, and purchases are a prime indicator of the failure of the financing to assist in the growth and development of small businesses.

Overriding Factors

In addition to the common components calculated through the use of loan performance factors, the proposed risk rating system allows for consideration of additional factors. The occurrence of these factors may lead SBA to conclude that an individual lender's composite rating is not fully reflective of its true risk. Therefore, the proposed risk rating system would provide for the consideration of overriding factors, which may only apply to a particular Lender or group of Lenders, and permit SBA to adjust a Lender's overall composite rating. The allowance of overriding factors in helping determine a Lender's risk rating would enable SBA to use key risk factors that are not necessarily applicable to all Lenders, but indicate a greater or lower level of risk from a particular Lender than that which the calculated score provides.

One of the most important overriding factors would be a Lender's on-site risk-based reviews/assessments usually performed on SBA's relatively large Lenders, or that may (under extraordinary circumstances) be performed on other Lenders whose performance demonstrates a highly unusual deviation from their peer group. SBA conducts on-site reviews of large Lenders, performs safety and soundness reviews of SBA Supervised Lenders, and uses certain off-site evaluation measures for less active Lenders. Consequently, these assessments, as a factor, may only be available for a fraction of SBA's approximately 5200 Lenders. Examples of other overriding factors that may be considered are: Early loan default trends; purchase rate or projected purchase rate trends; abnormally high default, purchase or liquidation rates; denial of liability occurrences; lending concentrations; rapid growth of SBA lending; inadequate, incomplete, or untimely reporting to SBA or inaccurate submission of required fees to SBA; and enforcement actions of regulators or other authority. This list is not all inclusive; however, SBA does not expect any of the overriding factors to affect a significant number of composite scores.

Request for Comments

SBA is undertaking a deliberative development of the Lender risk rating system. The proposed risk rating system utilizes predictive modeling and behavioral scoring systems developed by private sector industry leaders in credit risk analysis. SBA has and will continue to perform annual validation testing on the risk rating system, and will further refine the system as necessary to improve the predictability of its risk scoring. SBA is requesting comments from the public on all aspects of the proposed risk rating system.

To facilitate written comments on the proposed risk rating system, SBA will provide Lenders access to their own preliminary risk ratings, as well as average peer and portfolio performance information. SBA will provide Lenders access to this information through the use of the Lender Portal developed for SBA's Loan and Lender Monitoring System (L/LMS). Once the risk rating system is finalized, Lenders will have access to their final quarterly ratings through the portal. Additional guidance on portal access follows.

Lender Portal

Overview

SBA intends to communicate Lender performance to Lenders through the use of SBA's Lender Portal. The portal will allow Lenders to view their own quarterly performance data, including their most current composite risk rating. Lenders can also access data on peer group and portfolio averages. Consequently, a Lender will be able to gauge its performance relative to its peer group and the portfolio norm. While Lenders can view their ratings, their performance indicators, and peer and portfolio averages, they will not be able to view the individual ratings and performance indicators of other Lenders. The quarterly performance data will be overwritten on a quarterly basis; therefore, SBA recommends that Lenders save their performance data for their own tracking and trend analysis purposes.

Portal Data

SBA plans to update portal data quarterly approximately six to eight weeks after a calendar quarter ends. Lenders will only be able to access the most recent quarterly data. Lenders will not be able to access previous quarters' data following an update.

Correcting Portal Data

Portal data includes both summary performance and credit quality data. Because summary performance data is largely derived from data that Lenders provide to SBA through 1502 and 172 Reports, Lenders bear much of the responsibility for ensuring data accuracy. If a Lender reviews its performance components and they do not comport with its own data records, the Lender should confirm the accuracy of the underlying data. If the Lender determines that the data is inaccurate, it should seek to amend any incorrect data through SBA's normal processing channels (for example—for loan performance data, Lender should contact SBA's fiscal and transfer agent).

Credit quality data used to help establish certain component scores is derived from credit bureau reports of the borrower business and its principals/guarantors. To the extent that credit quality data relies on information that a Lender provides on the business, its principals, and guarantors contained in the loan application and as required to be updated by the Lender, the Lender must take responsibility for ensuring this information is correct, complete, and updated. SBA recognizes that underlying borrower credit data cannot be changed by SBA or a Lender. Therefore, any changes to data provided to credit bureaus must be reported directly to Dunn & Bradstreet or Trans Union, as appropriate, by the borrower. All corrections to portal data (both summary performance and credit quality data) will be reflected in the quarterly update following the quarter in which the correction is entered.

Portal Access

Lenders with at least one outstanding SBA loan will be able to apply for portal access. SBA will issue only one portal user account per Lender. Lenders must submit initial requests for a portal user account (or requests to switch or terminate a user) by regular or overnight mail to SBA at the following address: Office of Lender Oversight—Capital Access, Suite 8200; Mail Code 7011, ATTN: Lender Portal, U.S. Small Business Administration, 409 Third Street, SW., Washington, DC 20416.

Lenders must take the following steps in requesting portal access:

(1) Request must be made by a senior officer of the Lender (Senior VP or above).

(2) Request must be sent via regular or overnight mail to the address provided above.

(3) Request must be made using the Lender's stationery.

(4) Request must include the user's business card.

(4) The stationery and business card should include the Lender's name and address.

(5) The request should include the following data:

(a) SBA FIRS ID Number(s).

(b) Account user's name.

(c) Account user's title.

(d) Account user's mailing address at the Lender.

(e) Account user's telephone number at the Lender.

(f) Account user's e-mail address at the Lender.

(g) Requesting officer's name.

(h) Requesting officer's title.

(i) Requesting officer's mailing address at the Lender.

(j) Requesting officer's telephone number at the Lender.

(k) Requesting officer's e-mail address at the Lender.

Once SBA receives and approves the user request, the Agency will forward the approval to SBA's portal contractor for issuance of a user account name and password. The portal contractor will e-mail the user his or her user name and password within approximately two weeks of account approval. The user can then access its data by logging into the Lender portal Web page at https://pdp.dnb.com/pdpsba/pdplogin.asp.

Lender Portal Responsibilities

Lenders are responsible for complying with SBA's requirements in obtaining and maintaining the portal user accounts and passwords as set forth below and as published from time to time. Lenders are also responsible for timely informing SBA to terminate or switch an account if the person to whom it was issued no longer holds that responsibility for the Lender. Upon accessing the lender portal, Lenders must take full responsibility for protecting the confidentiality of the user password and lender risk rating information and for ensuring the security of the data.

Confidentiality Agreement

By clicking on the Portal log-in button to access the SBA Lender Information Portal (“Portal”), Lender will agree to use the Confidential Information (defined in the Portal) contained in the Portal only for confidential use within its own immediate corporate organization, and to hold and maintain the Confidential Information in confidence in accordance with the terms of the Agreement. Lender will agree to restrict access to the Confidential Information to those of its officers and employees who have a legitimate need to know such information for the purpose of assisting the Lender in improving the Lender's 7(a) or 504 program operations in conjunction with SBA's Lender Oversight Program and SBA's portfolio management (each referred to as a “permitted party”), and to those for whom SBA has approved access by prior written consent and for whom access is required by applicable law or legal process. If such law or process requires Lender to disclose the Confidential Information to any person other than a permitted party, Lender will agree to promptly notify SBA and SBA's Information Provider (defined below) in writing so that SBA and the Information Provider have, within their sole discretion, the opportunity to seek appropriate relief such as an injunction or protective order prior to Lender's disclosure. In addition, Lender will agree to ensure that each permitted party is aware of the requirements of the Agreement and to ensure that each such permitted party agrees to the terms and conditions. Lender will agree not to disclose, and will agree to protect from disclosure, Lender's password to enter the Portal. Further, any disclosure of Confidential Information other than as permitted by the Agreement may result in appropriate action as authorized by law. Lender also will agree to indemnify and hold harmless each of SBA and any provider of the Confidential Information from and against any and all claims, demands, suits, actions, and liabilities to any degree based upon or resulting from the unauthorized use or disclosure of the Confidential Information. “Information Provider” means Dun & Bradstreet. (Mail Provider Information notice to Dun & Bradstreet, Legal Department, 103 JFK Parkway, Short Hills, NJ 07078.)

No information contained in the Portal shall be relied upon for any purpose other than SBA's lender oversight and SBA's portfolio management purposes. In addition, Lender will acknowledge and agree that the Confidentiality Agreement is for the benefit not only of the SBA but also of any party providing the Confidential Information. Any such party shall have the right and standing to pursue all legal and equitable remedies against the Lender in the event of unauthorized use or disclosure.

Portal Inquiries

For general inquiries, a Lender may submit its e-mail to lender.portal@sba.gov. If a Lender needs to speak to an individual on a non-technical matter, it may contact Paul Bishop at 202-205-7516. SBA advises a Lender to state upfront its Lender name, address, FIRS number, and user name to expedite processing of all inquiries.