CUNA Regulatory Comment Call

May 10, 2006

Small Business Administration (SBA) Lender Risk Rating System

EXECUTIVE SUMMARY

• The Small Business Administration (SBA) has issued a proposal to institute a lender risk rating system. The rating system would be used to assess an SBA Lender’s 7(a) portfolio performance and a Certified Development Company’s (CDC’s) 504 loan portfolio performance.

• The proposed risk rating system utilizes predictive modeling and behavioral scoring systems developed by private sector industry leaders in credit risk analysis. Under the lender rating system, SBA would assign each Lender a composite rating to reflect SBA’s assessment of the potential risk to the government of that lender’s SBA portfolio performance. The proposed rating system allows for SBA to adjust a Lender’s overall composite rating based on overriding factors, which may only apply to a particular lender or group of lenders. 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 soliciting comments on all aspects of the proposed risk rating system, including the methodology.

• 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 Lender’s loan operations/portfolio and identify those Lenders whose portfolio demonstrates the need for enhanced SBA monitoring or other action. In addition, the lending rating system would serve as a vehicle to measure the aggregate strength of SBA’s 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.

• Once the risk rating system is finalized, Lenders will have access to their own quarterly performance data, including their most current composite risk rating, though the online Lender Information Portal developed for SBA’s Loan and Lender Monitoring System (L/LMS). Lenders will also be able to access data on peer group and portfolio averages through the Lender Portal. The web page for the Lender Portal is https://pdp.dnb.com/pdpsba/pdplogin.asp.

• Comments are due to SBA by July 15, 2006. Please send your comments to CUNA by June 30, 2006. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.coop and to Senior Regulatory Counsel Catherine Orr at corr@cuna.coop; or mail them to Mary or Catherine in c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the proposal, or you may access it on the Internet at:

http://a257.g.akamaitech.net/7/257/2422/01jan20061800/edocket.access.gpo.gov/2006/pdf/E6-6506.pdf

DESCRIPTION OF THE PROPOSAL

Composite Rating

• The composite risk rating SBA’s proposes to assign to every Lender would essentially be a measure of how each Lender’s loan performance compares to the loan performance of its peers. An individual Lender’s overall loan performance (derived using the factors described in the Rating Components section below) would be compared to its peers to derive that Lender’s composite risk rating. Lenders whose overall portfolio performance is worse than their peers will receive a higher (worse) score, while Lenders whose overall portfolio performance is better than their peers will receive a lower (better) score.

• SBA recognizes that it may not be equitable to compare all Lenders in a risk rating system unless they are separated into peer groups. Changes in loan performance would have dramatically different impacts on the portfolio performance of Lenders of different sizes. 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):

7(a) Lender Peer Groups CDC Peer Groups

100,000,000 or more $100,000,000 or more
10,000,000–$99,999,999 $30,000,000–$99,999,999
4,000,000–$9,999,999 $10,000,000–$29,999,999
1,000,000–$3,999,999 $5,000,000–$9,999,999
0–$999,999 (disbursed at least one loan in past 12 months) Less than $5,000,000
0–$999,999 (did not disburse at least one loan in past 12 months)  



• SBA proposes to assign a composite rating of 1 to 5 to each Lender based on their portfolio performance. According to the proposed descriptions, a rating of 1 would indicate the strongest portfolio performance. Lenders with a 1 rating would pose the least risk to SBA, requiring the lowest level of agency management oversight (relative to other Lenders in their peer Group). At the other end of the spectrum, a composite rating of 5 would indicate weak portfolio performance, highest risk, and therefore, the highest degree of SBA management oversight.

• According to SBA, this 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.

• Lenders with a composite rating of 1 would likely score much better than SBA averages in all or nearly all of the rating components. These Lenders 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 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).

• The SBA operations of a Lender rated 2 would likely be above average in all or nearly all of the rating components. 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. These Lenders 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 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 SBA loan program as demonstrated through onsite or off-site reviews and assessments (of mid-size and large Lenders). Given the fact these Lenders would present SBA with a lower level of risk, they would be subject to a lower level of SBA oversight compared to other Lenders in the same peer groups.

• The SBA operations of a Lender rated 3 would be considered about average in all or nearly all of the rating components. 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. These Lenders 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 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 (that is, 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. 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.

• The SBA operations of Lender rated 4 would be considered below average in all or nearly all of the rating components. 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. These Lenders would likely have a poorly managed (that is, 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). 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 could include such measures as 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.

• 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. These Lenders 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). 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.

Rating Components

• In general, the factors described below 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.

• For SBA lenders, SBA would base the composite rating on four factors:

  1. 12 month actual purchase rate
    This represents an historical measure of SBA purchases from the Lender in the preceding 12 months. 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).


  2. Problem loan rate
    This indicator shows current delinquencies and liquidation and predicts 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).


  3. 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
    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.


  4. Projected purchase rate derived from the SBPS
    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).


• For CDCs, SBA would base the composite rating on three factors:

  1. 12 month actual purchase rate
    This rate is an historical measure of SBA purchases from the CDC in the preceding 12 months. 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).


  2. 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).


  3. Average SBPS on loans in the 504 Lender’s portfolio
    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.


Adjustment to Composite Score

• 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 consider additional Lender-specific factors. As a result, SBA may decide to override the composite risk rating (either positively or negatively) and assign a different composite score.

• 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. 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. SBA does not expect any of the overriding factors to affect a significant number of composite scores.

• If SBA makes the determination to override the composite score, the agency will provide the Lender with an explanation of the reason(s) for the override.

Lender Portal

• Lenders will be able to view their composite ratings, their performance indicators, and peer and portfolio averages on the online Lender Portal. However, they will not be able to view the individual ratings and performance indicators of other Lenders. SBA believes this information will prove helpful to Lenders by allowing then to gauge their performance relative to their peer group and the portfolio norm.

• To facilitate comments on the proposal, SBA will provide Lenders access to their own preliminary risk ratings and average peer and portfolio performance information via the Lender Portal.

• 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 because the previous quarter’s data will be overwritten. Therefore, SBA recommends that Lenders save their performance data for their own tracking and trend analysis purposes.

• Data in the Lender Portal includes both summary performance and credit quality data. Summary performance data is largely derived from data that Lenders provide to SBA through Forms 1502 (Lender payment and remittance information) and 172 (Transaction Report on Loan Serviced by Lender). A Lender should seek to amend any incorrect performance data through SBA’s normal processing channels. 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, as appropriate. All corrections to Portal data will be reflected in the quarterly update following the quarter in which the correction is entered.

• 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. The request must be made by a senior officer of the Lender (Senior VP or above). Information on what information should be included in the request and where to send the request is noted in the proposal as well as on the Portal home page. The Lender should receive e-mail notification of the account access information (user ID and password) within approximately two weeks.

• 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. This means that Lenders agree to use the information contained in the Portal only for confidential use within its own immediate corporate organization. Lenders 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, 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. In addition, 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.

QUESTIONS REGARDING THE PROPOSAL

  1. SBA states that the descriptions for 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.

    Do you agree with the implementation of a rating system whereby each Lender is assigned a composite score?

    Yes____      No____

    Please explain why or why not.


















    Would you change any/all of the composite rating description(s)?

    Yes____      No____

    If yes, what modification(s) do you suggest?
















  2. SBA’s risk rating system emphasizes purchase metrics. SBA believes purchase metrics 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. Do you feel that the components/factors that go into the composite rating are appropriate?

    Yes____      No____

    Please explain why or why not. If not, what other/additional factors do you think would be more appropriate?
















  3. Do you feel that the allowance of overriding factors in helping determine a Lender’s risk rating would be sufficiently flexible?

    Yes____      No____

    Please explain.
















  4. Would having access to your credit union’s ratings, your credit union’s performance indicators, and peer and portfolio averages through the Lender Portal be helpful?

    Yes____      No____

    Please explain.
















  5. Do you have any concerns relating to the utilization of the Lender Portal – the process for making corrections to the data or the confidentiality agreement?

    Yes____      No____

    Please explain.
















  6. Other comments?
















Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 • mdunn@cuna.com
Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
Lilly Thomas • Assistant General Counsel • (202) 508-6733 • lthomas@cuna.com
Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com