SBA Lender Risk Rating System

SUMMARY: This notice implements changes to the Small Business Administration's (SBA's) Risk Rating System. The Risk Rating System is an internal tool to assist SBA in assessing the risk of the SBA loan operations and loan portfolio of each active 7(a) Lender and Certified Development Company (CDC) SBA loan operations and loan portfolio. Consistent with industry best practices, SBA recently redeveloped the model used to calculate the composite Risk Ratings to ensure that the Risk Rating System remains current and predictive as technologies and available data evolve. SBA is publishing this notice with a request for comments to provide the public with an opportunity to comment.

DATES: This notice is effective April 29, 2014.

Comment Date: Comments must be received on or before June 30, 2014

ADDRESSES: You may submit comments, identified by Docket number SBA-2014-0003 by using any of the following methods:

* Federal eRulemaking Portal: http://www.regulations.gov. Identify comments by "Docket Number SBA-2014-0003, SBA Lender Risk Rating System," and follow the instructions for submitting comments.

* Mail: Brent Ciurlino, Director for Office of Credit Risk Management, U.S. Small Business Administration, 409 3rd Street SW., 8th Floor, Washington, DC 20416.

* Hand Delivery/Courier: Brent Ciurlino, Director for Office of Credit Risk Management, U.S. Small Business Administration, 409 3rd Street SW., 8th Floor, Washington, DC 20416.

All comments will be posted on http://www.Regulations.gov. If you wish to include within your comment confidential business information (CBI) as defined in the Privacy and Use Notice/User Notice at http://www.Regulations.gov and you do not want that information disclosed, you must submit the comment by either Mail or Hand Delivery and you must address the comment to the attention of Brent Ciurlino, Director for Office of Credit Risk Management, U.S. Small Business Administration. In the submission, you must highlight the information that you consider is CBI and explain why you believe this information should be held confidential. SBA will make a final determination, in its discretion, of whether the information is CBI and, therefore, will be published or not.

FOR FURTHER INFORMATION CONTACT: Brent Ciurlino, Director, Office of Credit Risk Management, U.S. Small Business Administration, 409 Third Street SW., 8th Floor, Washington, DC 20416, (202) 205-3049.

SUPPLEMENTARY INFORMATION:

I. Background Information

(A) Introduction to the Risk Rating System

The Risk Rating System is an internal tool that uses data in SBA's Loan and Lender Monitoring System (L/LMS), borrower data provided by Dun & Bradstreet (D&B), and certain macroeconomic factors to assist SBA in assessing the risk of the SBA loan performance of each 7(a) Lender and CDC (each, an SBA Lender) on a uniform basis and identifying those SBA Lenders whose portfolio performance, or other lender-specific risk-related factors, may demonstrate the need for additional SBA monitoring or other action. The Risk Rating System also serves as a vehicle to measure the aggregate strength of SBA's overall 7(a) loan and CDC loan (also known as a 504 loan) portfolios and to assist SBA in managing the related risk. In addition, SBA uses Risk Ratings to make more effective use of its lender review and assessment resources.

Under SBA's Risk Rating System, SBA assigns all SBA Lenders a composite Risk Rating of 1 to 5, based on empirical data. The rating reflects SBA's measurement of the SBA Lender's potential portfolio risk. In general, a rating of 1 indicates least risk and that the least degree of SBA oversight is likely needed, while a 5 rating indicates highest risk and that the highest degree of SBA oversight is likely needed. The composite rating is calculated using several component variables. The component variables were developed using step-wise regression analysis to determine the components that provided a linear regression formula that was most predictive of actual purchases over a one year period.

On May 1, 2006, SBA published a notice and request for comment in the Federal Register seeking comments on the proposed Risk Rating System (72 FR 25624). A final notice was published in the Federal Register on May 16, 2007 (72 FR 27611). On March 1, 2010 SBA published a notice describing revisions to the Risk Rating System (75 FR 9257). SBA also published a correction to the revised Risk Rating System notice on March 18, 2010 (75 FR 13145).

(B) Redevelopment

Typically, under industry best practices, custom credit scoring models are redeveloped approximately every three to five years to reflect changing conditions, portfolio shifts, and to incorporate additional data that may have become available. This redevelopment is consistent with such practices and is necessary to ensure that SBA's Risk Ratings provide an accurate measurement of lenders' SBA portfolio performance. SBA's portfolio has changed significantly over the past several years; the portfolio has continued to grow, and the composition of loan products (delivery methods) has migrated. In addition, the economy and, in particular, the small business lending environment has changed since the last redevelopment in 2010.

During this redevelopment, SBA reviewed over 200 potential variables from SBA's L/LMS archive along with nearly 400 potential variables from D&B sources. SBA selected these potential variables based on its experience working with such models over the past several years. The D&B variables included attributes from its detailed trade repository providing the highest level of trade data resolution. The variables were then run through rigorous statistical techniques and the most predictive combinations of variables were chosen as components in the redeveloped Risk Rating model.

II. The Redeveloped Risk Rating Model

SBA followed common industry best practices and internal control standards when redeveloping and validating the Risk Rating model. The redeveloped model was independently validated by personnel other than the staff responsible for the redevelopment. The redeveloped model used to calculate the composite Risk Ratings is an updated version of the previous models. Like the previous models, it is a custom credit scoring model that predicts the likelihood of an SBA Lender's loan purchases over the next 12 months. However, whereas previous models relied primarily on SBA Lender-level portfolio data (e.g., Past 12-Months Actual Purchase Rate, Gross Delinquency Rate, 6 Month Liquidation Rate), the redeveloped model relies primarily on loan-level and borrower data. The new model predicts the probability of default for each loan in an SBA Lender's portfolio and multiplies this probability by the outstanding loan amount at the time the ratings are formulated.

The most notable changes in the redeveloped Risk Rating System are:

1. Risk Rating based on loan-level projected purchase rates (PPRs). Unlike in previous models, which used a combination of lender-level loan portfolio data and loan-level data to predict an SBA Lender's overall probability of purchase requests, the redeveloped model computes the PPR of each individual SBA-guaranteed loan in an SBA Lender's portfolio. As described further in Section IV below, the individual loan-level PPRs are then aggregated to obtain the SBA Lender's overall PPR, which is then used to calculate the composite Risk Rating [1-5].

2. Risk Rating no longer determined by peer group. In previous models, SBA reported Risk Ratings by peer groups based on SBA loan portfolio size. When the Risk Rating System was first developed, an SBA Lender's Risk Rating was a measure of how each SBA Lender's loan performance compared to the loan performance of its similarly-sized peers. In the redeveloped model, Risk Ratings are no longer based on a relative scale. Testing during redevelopment revealed that this method of calculating the Risk Ratings is more predictive of performance than the previous peer group scoring because the Risk Ratings are now based solely on a lender's PPR from its specific portfolio.

3. Segmentation of the overall portfolios. Prior models used only two rating formulas: One for the 7(a) program and one for the CDC program. The components and weightings of components were the same within the 7(a) Lender population and within the CDC population. The redeveloped model uses seven rating formulas (five for 7(a) Lenders; two for CDCs) based on a segmentation approach. Statistical analysis showed that grouping loans of similar types increased the predictiveness of the overall system. Loans are segmented by loan type (revolver-type or fixed-end), current payment status, and loan size. A loan's PPR is calculated based on a combination of components that is uniquely predictive for loans in that segment. See paragraph IV(B) for a detailed discussion of the seven segments and the components used in each segment.

4. Updated components in the regression formulas. The redeveloped model continues to use loan-level data (provided by the SBA Lenders and SBA's own data) and external risk assessment data (provided by D&B) that is derived from third party business and consumer credit bureau data. Several of the new components are based on borrower payment trends, similar to the information used to compute the Dollar Weighted Average Financial Stress Score (FSS) component in the previous model. For example, several of the new components incorporate information relating to borrower trade accounts. A trade account records current information on a relationship between a supplier and purchaser. D&B collects and aggregates all available trade accounts on a monthly basis for its entire global database of commercial entities.

--This is a summary of a Federal Register article originally published on the page number listed below--

Notice of revised Risk Rating System; request for comments.

Citation: "79 FR 24053"

Document Number: "Docket No: SBA-2014-0003"

Federal Register Page Number: "24053"

"Notices"