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Office of Credit Risk Management

2014 Government Relations Conference

Office of Credit Risk Management

1. SMART & ALP Renewal Reviews

2. Most Frequent SMART / ALP Review Findings

3. Lender Risk Ratings

4. SMART Benchmarks

i. Methodology

ii. Categories

iii. Metrics being Benchmarked

iv. Qualitative Factors

5. Analysis of CDC Annual Report Information

6. Supervisory & Enforcement Actions

7. Voluntary Decertifications & Inactive CDCs

2 2014 Government Relations Conference

SMART & ALP Renewal Reviews

SMART Reviews:

2013 – Conducted 7 SMART Developmental On-site Reviews and

initiated 20 SMART Remotely Conducted (Virtual) Reviews

2014 – Planned 30 SMART Reviews – to be conducted Remotely and

On-site (when appropriate).

ALP Renewals:

2013 – completed 16 ALP Renewals – some provided full two (2) year

renewal and others limited to 6 to 12 months to allow OCRM to monitor

CDC implementation of corrective actions (primarily related to internal

controls policy and/or independent loan review).

2014 – completed 13 ALP Renewals and 57 additional Renewal Requests

are to be processed in 2014.

2014 Government Relations Conference 3

SMART & ALP Renewal Reviews

Most Frequent Findings: Failure to comply with requirement that CDCs operate with a Board-approved internal

controls policy which includes independent loan review and classification policy (loan

ratings). OCRM prepared FAQs on Internal Controls Policy to assist CDCs who are

in need of these policies.

Need for improvement in Intensive Servicing (timely site visits, monitoring of taxes and

bankruptcies, preparation of liquidation plans, and analysis of ability to pursue guarantors).

OCRM organized a webinar with OFPO and NADCO on SOP 50 55 in an effort to

communicate SBA 504 servicing and liquidation requirements to CDC community.

Closing procedures need improvement – failure to verify income via 4506 process, failure

to document use of proceeds, CDCs not being named as lender loss payee in hazard

insurance policies, projects funded prior to completion or issuance of certificate of

occupancy. OCRM will continue to work with the CDC community and NADCO in

an effort to communicate the importance of following SBA program requirements.

We are also following up with the relevant CDCs on issues related to harm that

were identified in the SMART Reviews.


New Lender Purchase Rating (LPR)

5

Currently known as Lender Risk Rating (LRR)

Multiple approaches were evaluated and the full redeveloped model with

the highest predictive power was selected.

The final model predicts total expected 12 months purchase dollars and

rates and associated LPR* through the following phases:


Multiply loan

probability of

purchase by

outstanding balance

to obtain loan level

predicted purchase

dollar

Phase 1:

Calculate loan

level purchase

probability and

aggregate $

amount

Phase 2:

Project purchase

amount per

lender

Phase 3:

Re-rank lenders 1

to 5 in a more

accurate model

504 New LRR # of

CDCs # of Loans

Total Active

Balance (billions)

Risk Rating

1-2 154 47,011 $21

Risk Rating 3 69 12,092 $5.2

Risk Rating

4-5 30 1,516 $.58

Total 253 60,619 $26.8

504 Active CDCs Lender reported data through 5/31/13

504 Inactive CDCs Lender reported data through 5/31/13

6

504 New LRR # of

CDCs # of Loans

Total Active

Balance (billions)

Risk Rating

1-2 14 170 $.047

Risk Rating 3 3 74 $.023

Risk Rating

4-5 6 79 $.03

Total 23 323 $.10

► Previous model captures 21 Active CDCs risk rated 4-5* vs. 30 in new model

New LPR Results

* 2 Active CDCs were overridden to a 5 LRR.


Step I. New LPR Model Features

7

Raw score indicating

expected total portfolio

purchases at the lender

level

Probability of Purchase PPR at

loan level, which is then

aggregated to lender level to

produce LPR ( 1 – 5 rating)

Current Model New Model

Outcome

Variables

• 6-month Liquidation rate

• 6-month net cash flow

(Lender: positive or negative)

• FSS Score

• Delinquency Rate (Lender)

• Past Due Rate (Lender)

• Last 12-Month Purchase Rate

(Lender)

• Delivery Method

• SBPS Score

• Average Age (MOB), Total

Dollars (Discretized)

• SBPS

• MOB

• Age of Business

• D&B Detailed Trade Attributes

• % Accounts Past Due

• % Accounts 31+ Past Due

• % Current – Long Term

Trend

• # of Account on Database

for Last 4 Months

• Status

• Housing Price Index Change

Ratio

New LPR Model Features


Benchmark Methodology

One benchmark scorecard is established for all 504 lenders/CDCs.

This scorecard will be annually updated and will provide a SMART

overall score (12 to 60).

A“20/60/20” rule is used to establish the less than acceptable,

acceptable, and preferred thresholds.

The “Preferred” threshold uses the best 20th percentile of 2005

lender performance data.

2005 was a period of time when the overall economy was stable and the

504 program was essentially subsidy neutral (net cash yields close to

zero) and thus is the preferred state of performance.

The “Less Than Acceptable” threshold is defined with the worst 20th

percentile of current 2013 lender performance data.

This approach enables SBA to encourage lenders to minimize risky

behavior, while still taking into account the residual effects of the

economic recession.


SMART Benchmark Categories


SMART

Benchmarks

(12)

• Solvency

• Management and Board Governance

• Asset Quality and Servicing

• Regulatory Compliance

• Technical Issues & Mission

SMART 1.0 Benchmarks


504 SMART RATES Preferred (+1)

(+ 1)

Acceptable (+3)

(+ 3)

Less Than Acceptable (+5)

Solvency

5 Year Cumulative Net Yield > -1 % ≥ -3% and ≤ -1% < -3%

12 Month Default Rate 0% > 0% and ≤ 5% > 5%

5 Year Default Rate 0% > 0% and ≤ 5% > 5%

Management

Lender Purchase Rating (formerly LRR) 1,2 3 4,5

High Risk Origination Rate* < 0% ≥ 0% and ≤ 13% > 13%

Loans in Purchase Status over 3 Years Rate <= 0% > 0% and <= 27% > 27%

Asset Quality

Stressed Rate < 3% >= 3% and ≤ 10% > 10%

Recovery Rate (Over last 5 years) > 33% ≤ 33% and > 6% ≤ 6%

Early Problem Loan Rate <= 0% > 0% and ≤ 4% > 4%

Regulatory Compliance Minimum Level of 504 Activity >= 4 < 4

Technical Issues Average SBPS (weighted) > 197 >= 188 and <= 197 < 188

Industry Concentration Rate < 13% >= 13% and ≤ 28% > 28%

** 504 SBPS risk categories - high risk (< 160) , medium risk (160 - 199), and low risk ( ≥ 200)

SMART 1.0 Benchmarks - Definitions


Definitions of Key Metrics

SMART Category Attribute Description Loan Level Attributes Lender Level Equation

Solvency

5 Year Cumulative Net Yield

Numerator - Cumulative net cash flow, including purchase, recovery, origination and servicing fees Denominator - SBA's guarantee share of the gross balance

net_cash, balsba (sum(lst60mn_net_cash_cum)/ 5) / av60mn_balsba

12 Month Default Rate

Numerator - Default Amount over the last 12 months, defined by gross purchase amount Denominator - Active Gross Balance averaged over the last 12 months + the Default Amount over the last 12 months

lst12mnpurch_amtgrs, lst12mnpurch_balgrs

sum(lst12mnpurch_amtgrs) / sum (lst12mnpurch_balgrs)

5 Year Default Rate

Numerator - Default Amount over the last 5 years, defined by gross purchase amount Denominator - Active Gross Balance averaged over last 5 years + Default Amount over last 5 years

lst60mndefault_amtgrs, lst60mndefault_balgrs

(sum(lst60mndefault_amtgrs)/5) / sum (lst60mndefault_balgrs)


Management

Lender Purchase Rating (formerly LRR) A Lender Rating based on forecasted purchases for the next 12 months n/a calcrating

High Risk Origination Rate*

Numerator - Gross Approval Amount for young (mob ≤ 36) risky (original SBPS < 140) *** loans that have been disbursed

Denominator - Gross Approval Amount for young loans (mob ≤ 36) that have been disbursed

lst36mn_highriskorig_amtgrs, lst36mndisb_amtgrs

sum(lst36mn_highriskorig_amtgrs) / sum(lst36mndisb_amtgrs)

Loans in Purchase Status over 3 Years Rate

Numerator - Gross Balance of loans in purchase status over 3 years that were purchased due to liquidation

Denominator - Gross Balance of all loans currently in purchase status due to liquidation liqd_for_36_amtgrs, actvpurch_liqd

sum(liqd_for_36_amtgrs) / sum (actvpurch_liqd)


Asset Quality

Stressed Rate

Numerator - Stressed (past due (31-59 days past due), deferred, delinquent (60 or more days past due)) balance

Denominator - Active Gross Balance stressed_balgrs, activ_balgrs

sum(stressed_balgrs) / sum(activ_balgrs)

Recovery Rate (Over last 5 years)

Numerator - Cumulative Recovery Amount (funds realized after purchase due to liquidation) of loans charged off within the last 5 years

Denominator - Cumulative Purchase Amount due to liquidation for loans charged off within the last 5 years

purchpringrs, chargeoffpringrs, choff_dt, lndr_dt

(sum(lst60mn_co_purchpringrs) - sum(lst60mn_co_chargeoffpringrs)) /sum(lst60mn_co_purchpringrs)

Early Problem Loan Rate

Numerator - Active Gross Balance for young (mob ≤ 36) loans that have had either a deferred, delinquent (60 or more days past due),

purchased, or charged off status within 18 months of disbursement

Denominator - Gross Approval Amount for young loans (mob ≤ 36) that have been disbursed

lst36mnearlyprob_amtgrs, Lst36mndisb_amtgrs

sum(lst36mnearlyprob) / sum(lst36mndisb_amtgrs)


Regulatory Compliance Minimum Level of 504 Activity

The number of 504 debentures disbursed in the last two years dbm twoyear_loan_count


Technical Issues

Average SBPS (weighted)

Average Small Business Portfolio Score (SBPS) weighted by active gross balance balscore, balscrden sum(balscore) / sum (balscrden)

Industry Concentration Rate

Numerator - Gross Balance of loans in a given industry subsector (NAICS 3 digit code) Denominator - Gross Balance

naicsubsect_cd, activ_balgrs top_industry_balgrs /sum(balgrs)

SMART 1.0 Qualitative Factors Solvency

• Reserves for future operations

• Liquidity risk and management

Management & Board Governance • Board-approved internal controls policies: Independent loan review & Loan Classification System

• Business Strategy and Planning

• Audit and Review Programs

• IT Operations

• Management of Risk Concentrations

• Professional Service Contractors

Asset Quality & Servicing • Credit Administration

• Servicing and Liquidation Management

• Potential “Harm” Issues

Regulatory Compliance • Timely and complete submission of CDC Annual report (and PCLP reserve report, if required

Technical Issues and Missions • CDC support of “other economic development initiatives”

• Jobs Created/Retained


Analysis of CDC Annual Report Information

CDCs are required to submit their Annual Report to SBA within 180

days after then end of their fiscal year and CDCs with 504 portfolios

of $20 million or more are required to have their financial audited by

a CPA.

OCRM is conducting a comprehensive review of all CDC Annual

Reports in order to compile key operating CDC information on items

such as profitability, reserves, cash-flow, investment in local

economic development, jobs created/retained, executive

compensation, CDC sponsorship, and business transactions

involving interested parties.


Supervisory and Enforcement Actions

Supervisory Actions: these are typically confidential in nature and not

released to the public. Examples include Risk Rating downgrades,

shortened or non-renewal of delegated authority, required corrective

actions, and increased reporting.

Enforcement Actions: in the past two years, SBA has taken two

formal enforcement against CDCs. Enforcement actions are made

public by the SBA. The most recent action was issued on 1/31/2014

against SEM Resource Capital and the previous enforcement action

was issued in December of 2012 against EDF Resource Capital.

Details regarding both enforcement actions can be found on the

SBA’s website.


Voluntary Decertifications and Inactive CDCs

Voluntary Decertifications

Over the past two (2) years, ten CDCs have voluntarily decertified

their CDC status and their portfolios were transferred to other

entities for servicing. SBA’s consent, pursuant to 13 CFR 120.857,

to a CDC’s voluntary withdrawal from the 504 program should not

be construed as an SBA determination that the CDC is in violation

of any SBA Loan Program Requirement.

Inactive CDCs

Currently, there are approximately 30 CDCs nationally that are not

in compliance with either: a) 13 CFR 120.828(a) which states that

“a CDC is required to receive SBA approval of at least four 504

loan approvals during two consecutive fiscal years” and/or b) 13

CFR 120.130 which states that CDCs must submit their Annual

Reports to SBA within 180 days of their fiscal year end.


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