CUNA Comment Letter
SBA Lender Risk Rating System Proposal
July 13, 2006
Mr. John M. White
Deputy Associate Administrator
Office of Lender Oversight
U.S. Small Business Administration
409 Third Street, S.W.
Washington, D.C. 20416
Dear Mr. White:
The Credit Union National Association (CUNA) is pleased to provide comments on the Small Business Administrations (SBAs) proposal to institute a lender risk rating system. The rating system would be used to assess an SBA Lenders 7(a) portfolio performance and a Certified Development Companys (CDCs) 504 loan portfolio performance. We understand that the proposed rating system is not intended to be a lender grading system. Rather, it is intended to be an internal tool used by the SBA to assess the risk of each lenders loan operations/portfolio and identify those lenders whose portfolio demonstrates the need for enhanced SBA monitoring or other action. Once the risk rating system is finalized, lenders will have access to their own quarterly performance data, including their most current composite risk rating, through the online Lender Information Portal. By way of background, CUNA represents approximately 90% of the nations more than 8,800 state and federal credit unions which serve 87 million members. The proposed risk rating system is important to our credit union members that are involved in those two SBA lending programs. These comments were developed with input from our credit union members, including members of CUNAs Lending Council.
SUMMARY OF CUNAS COMMENTS
- CUNA appreciates SBAs work to formulate a methodology for a lender risk rating system as part of its efforts to continuously enhance the agencys 7(a) and 504 guaranteed loan programs.
- We have concerns about the delinquency calculation used in the problem loan rate component as well as the use of credit scores to derive the Small Business Predictive Score (SBPS) and the Projected Purchase Rate.
- We encourage the SBA to spell out in more detail how the rating components and peer comparisons are actually factored together to obtain the composite rating.
- We suggest the SBA revise the peer group categorizations to take into account the differences between new lenders and seasoned lenders as well as the differences between regions.
- It is important to provide for flexibility for a lenders composite rating to be adjusted (overridden) in appropriate situations, but the agency should make the process as objective as possible so there is no appearance of impropriety or favoritism.
- We think it would be beneficial for lenders to be able to access historical data, not just the current quarters data, via the Lender Portal.
- If SBA decides to proceed with implementation of a lender risk rating system, CUNA recommends a testing period prior to roll out so the agency can ascertain whether the system reflects what it is intended to reflect and make adjustments as necessary.
CUNA commends the effort of the SBA to create a system to evaluate the portfolios of SBA lenders based on objective factors applied in a uniform manner. Credit unions are required by National Credit Union Administration regulations to rate the risk of their member business loan portfolio on a monthly basis. We believe that this represents sound management practice. As a complement to this existing reporting system, this proposed SBA system would be another tool to enable credit unions and other SBA lenders to manage the risk in their loan portfolios. According to the proposal, the lending rating system would also serve as a vehicle to measure the aggregate strength of SBAs overall 7(a) and 504 loan portfolios and to assist the agency in managing the related risk. SBA plans to use the lender rating system to make more effective use of its on-site and off-site lender review and assessments resources. We certainly support the SBAs goals of enhancing its administration of these two important guaranteed loan programs. While we generally support the proposed rating system, we have some concerns, which are described below.
We have several concerns with the common rating components, which would be used to measure an individual lenders overall loan performance. First, the problem loan rate would be used to show current delinquencies and liquidation and predict potential future purchases by SBA. The problem loan rate would be calculated by dividing total gross outstanding dollars of a lenders 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). The delinquency calculation of a financial institutions SBA portfolio can be skewed when compared to other financial institutions. For example, if a lender uses SBA guarantee programs liberally, that lender would most likely have a lower delinquency rate on their SBA portfolio than a lender that used the guarantee programs more judiciously. In our view, the second lender does not necessarily represent a greater risk to the SBA if they are able to manage their portfolio to an acceptable level of actual losses. In this case, the lender would essentially be penalized for their decision to use the SBAs programs when it is truly appropriate and necessary for the small business to get the credit. Moreover, we believe the term total gross outstanding dollars that are 90 or more days delinquent should be revised to clarify that it refers only to the lenders SBA loans.
Second, the SBA is proposing to use credit scores to derive both the Small Business Predictive Score (SBPS), a portfolio management credit score based upon a borrowers business credit report and principals consumer credit report, and the Projected Purchase Rate, a 12-month projection of future performance based on the most current credit data on a borrowers payment history. The credit scores for businesses are still evolving and, as a result, may not be sufficiently robust to be used as part of a third partys scrutiny of a lenders portfolio. We understand that some SBA lender still have a no-hit ratio of approximately 50% for their applicants. We also understand that some SBA lenders have noticed errors in the reporting that affect the credit scores. Issues with credit scores can be addressed by the lender during the underwriting process, but that information would not be available to the SBA. One of the factors that can affect a score is credit line utilization. A small business that has a $10,000 line with a balance of $9,000 has the same credit line utilization as a business with a $500,000 line and a $450,000 balance, but the latter obviously represents a greater risk to an SBA portfolio although their scores may be impacted similarly. Credit scores are a part of the underwriting, not the sole factor in the decision. Yet the SBA is proposing to use credit scores to derive two of the four factors that will comprise a lenders ranking.
Third, in our view the proposed system places an overemphasis on purchase metrics. It seems deficient on the origination side. Traditionally, it takes a commercial loan one to three years to go bad. In the case of SBA loans, this results in purchase. If the rating system emphasizes purchase rates, it is reactively dealing with after-the-fact data instead of proactively preventing defaults.
Under the proposed lender rating system, SBA would assign each lender a composite rating of 1 to 5 to reflect SBAs assessment of the potential risk to the government of that lenders SBA portfolio performance. An individual lenders overall loan performance would be compared to its peers to derive that lenders composite risk rating. It is unclear from the proposal exactly how SBA would combine the common rating components and peer comparison to derive an individual lenders composite rating score. For example, would one rating factor be weighted more than the others? It would be helpful for the SBA to elaborate on that process so that lenders understood in more detail how their composite rating is assigned and are better able to determine how to improve their rating.
We feel it would be beneficial for institutions to have a composite rating which could be used as a benchmark for their particular loan performance and how it compares to the loan performance of their peers. We recognize it is an enormous undertaking to design a system comprehensive enough to rank lenders of all sizes and with broadly varying tenures of making loans. On the whole, we feel that the peer groups as described in the proposal (based on outstanding SBA guaranteed dollars) are appropriate. The various peer groups would seem to address the size issue. However, the system does not appear to take into account the differences between seasoned and new lenders. Considering the large influx of new lenders over the past two years, this would seem to be a major factor. Moreover, we strongly urge the SBA to ensure the new system would take into account geographical or regional categorization. Some lenders have a greater regional concentration and, therefore, present more of a potential risk to the agency than do other lenders.
CUNA suggests that in addition to less oversight as the rating improves that the SBA delegate more latitude in underwriting authority to lenders with a composite rating of 1. For example, the SBA could speed up the approval process for a lender with a strong composite rating to move up in lending designation from the General Program (GP) to the Certified Lender Program (CLP) and the Preferred Lender Program (PLP). As another example, in the case of PLP lenders, as long as no issues are disclosed on Form 912 (Statement of Personal History) during the application process, the SBA does not review the document. However, if there is an issue disclosed, the loan is not eligible for PLP processing and must be sent to the local SBA district office. A PLP lender with a composite rating of 1 could be permitted to make the determination that an applicant is eligible because the prior criminal offense disclosed is sufficiently minor or remote in time.
CUNA supports the allowance for overriding factors in those cases where the SBA believes that a lenders calculated composite rating may not fully reflect the level of risk that individual lender presents. There may be extraordinary or extenuating circumstances in which it would be proper and fair for the SBA to override the composite risk rating (either positively or negatively) and assign a different composite score. It would be beneficial for the SBA to provide greater detail as to how this process would work, especially as it is a subjective part of an objective model.
With the new system, lenders will be able to view their current quarterly composite ratings, their performance indicators, and peer and portfolio averages on the online Lender Portal. Again, this will assist lenders in comparing their processes with those of similar lenders, allowing them to improve.
The proposal indicates that lenders will not be able to access previous quarters data following an update because the previous quarters data will be overwritten. Therefore, for historical tracking and trend analysis purposes, lenders would have to save their performance data. We encourage the SBA to allow lenders to access this historical data through the portal.
Further, data in the Lender Portal includes both summary performance and credit quality data. 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, the lender must take responsibility for ensuring this information is correct, complete, and updated. Any changes to data provided to credit bureaus must be reported by the borrower directly to Dunn & Bradstreet or Trans Union. This may be time-consuming if corrections need to be made frequently and if the credit bureaus are slow to enter the corrected data.
Since this system will be new to the agency and SBA lenders, some fine-tuning may be needed. We recommend the SBA consider delaying rolling it out until the agency has had time to test the system to verify that the composite ratings comport with what audits have found as well as whether the rating factors are the best measures. The SBA could select various types of lenders (such as new and seasoned, large and small portfolio lenders) as beta lenders to see how this rating and system complies before it is fully implemented as a test stage for all SBA lenders. We feel a testing period would help limit any potential confusion accompanying implementation of the new rating system.
Thank you for the opportunity to comment. If you have any questions about this letter, please contact me by phone at (202) 508-6743 or by e-mail at firstname.lastname@example.org.
Senior Regulatory Counsel
Credit Union National Association