Business Loan Programs; Premier Certified Lenders Program Alternative Loan Loss Reserve Pilot Program, 30323-30331 [E6-8039]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 71, Number 102 (Friday, May 26, 2006)]
[Proposed Rules]
[Pages 30323-30331]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-8039]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

RIN 3245-AF23


Business Loan Programs; Premier Certified Lenders Program 
Alternative Loan Loss Reserve Pilot Program

AGENCY: Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: The U.S. Small Business Administration (``SBA'' or ``the 
Administration'') proposes to amend its Premier Certified Lenders 
Program (``PCLP'') in accordance with recent statutory amendments to 
the PCLP. Presently, under the PCLP, participating Certified 
Development Companies (``CDCs'') have increased authority in connection 
with making and servicing loans made under SBA's development company 
loan program (``504 Program''). One PCLP requirement relates to a loan 
loss reserve fund (``LLRF'') which a CDC participating in the PCLP 
(``PCLP CDC'') must maintain to cover losses it may incur in connection 
with the 504 Program loans (``504 Loans'') it has made under the PCLP 
(``PCLP loans''). Recent statutory changes to the PCLP include two 
pilot programs related to PCLP LLRF requirements. One pilot (``Pilot 
1'') changes LLRF requirements by requiring the value of an LLRF to 
equal 1 percent of the combined outstanding balances of each debenture 
issued by a PCLP CDC to fund a PCLP loan (``PCLP Debenture''), instead 
of the combined original face value of those PCLP Debentures. Another 
pilot (``Pilot 2'') authorizes certain PCLP CDCs with significantly 
large LLRFs to elect to meet alternative LLRF requirements in lieu of 
certain existing PCLP LLRF requirements. The proposed regulations would 
implement requirements, procedures, and guidelines relating to Pilot 1 
and Pilot 2.

DATES: SBA must receive comments on or before July 25, 2006.

ADDRESSES: You may submit comments, identified by RIN number, by any of 
the following methods: (1) Federal eRulemaking Portal: https://
www.regulations.gov; (2) E-mail: Charles.Thomas@SBA.gov. Include RIN 
Number in the subject line of the message; (3) Fax: (202) 205-7722; (4) 
Mail: Charles Thomas, Director, Program Development Division, Office of 
Financial Assistance, U.S. Small Business Administration, 409 Third 
Street, SW., Washington, DC 20416; (5) Hand Delivery/Courier: 409 3rd 
Street, SW., Washington, DC 20416, c/o Charles Thomas.

FOR FURTHER INFORMATION CONTACT: Charles Thomas, Director, Program 
Development Division, Office of Financial Assistance, Small Business 
Administration, 409 Third Street, SW., Washington, DC 20416, (202) 205-
6656, Charles.Thomas@SBA.gov.

SUPPLEMENTARY INFORMATION:

Statutory Basis for This Proposed Rulemaking

    SBA must amend the PCLP LLRF regulatory requirements established 
pursuant to Title V (``Title V'') of the Small Business Investment Act 
of 1958, as amended (the ``Act''), to conform with amendments to Title 
V contained in Public Law 108-232, enacted on May 28, 2004 (``Pilot 1 
and Pilot 2''). Pilot 1 and Pilot 2 were enacted with the ultimate goal 
of having each PCLP LLRF more accurately correspond to the risk of loss 
it secures.

Overview of the PCLP and the Basis for Pilot 1 and Pilot 2

    While access to capital is vital to the success of small 
businesses, many find it difficult to access financing, particularly 
long term financing. SBA's lending programs address these

[[Page 30324]]

difficulties by providing a critical stream of funding to small 
businesses. Last year, SBA loan programs supplied $21 billion in 
capital, accounting for 40 percent of all long-term small business 
lending to this country's entrepreneurs. One of SBA's most important 
loan programs is the 504 Program.
    The 504 Program provides small businesses with long-term, fixed-
rate financing to acquire major assets, such as heavy machinery and 
equipment, land, and buildings, with the overall goal of enhancing the 
economic development of a particular community or region. A typical 504 
Loan has three components: (1) A loan from a private-sector lender, 
secured by a senior lien, covering up to 50 percent of the project 
cost; (2) a loan from an SBA authorized Certified Development Company, 
secured by a junior lien position, covering up to 40 percent of the 
cost; and (3) an equity contribution of at least 10 percent from the 
small business. The CDC obtains the funds it needs to make its loan to 
the small business by selling a debenture that is 100 percent 
guaranteed by SBA. The maximum SBA debenture under the 504 Program is 
generally $1.5 million, but it is $2.0 million if the proceeds of the 
504 Loan will be directed toward certain public policy goals set forth 
in Title V, and $4.0 million when the project is for a small 
manufacturer as defined in Title V. In FY 2005, SBA approved about $5 
billion in lending to approximately 9,200 small businesses through the 
504 Program.
    Currently, under non-PCLP 504 Loan processing procedures, SBA 
analyzes each loan proposal to determine its creditworthiness and its 
conformance with SBA's regulations and policies, which are designed to 
control program risk. As the 504 Program expanded, however, SBA's 
budget constraints limited its capacity to process and service 
expeditiously the expanding number of 504 Loans. The PCLP was thus 
conceived to transfer substantial 504 Program lending and servicing 
authority to qualified CDCs, thereby reducing the demand for SBA 
resources and improving 504 Loan turn-around time. However, to ensure 
adequate program oversight and to protect the Federal Government from 
undue risk of loss, PCLP CDCs were required to: (1) Meet and maintain 
several additional qualifications and standards; (2) implement certain 
critical management controls; (3) reimburse SBA for 10 percent of any 
loss SBA incurred in connection with any of its PCLP Debentures; and 
(4) contribute and maintain an SBA-controlled LLRF equal to one percent 
of the aggregate of the face values of each of its PCLP Debentures.
    Participation in PCLP has expanded gradually since its 1997 
inception to nearly 30 PCLP CDCs, which collectively accounted for 
approximately $720 million in 504 lending in FY 2005. Losses under the 
program have been minimal thus far. As noted above, each participant 
must maintain an LLRF equal to one percent of the sum of the face 
values of each of its outstanding PCLP Debentures, even as the 
outstanding balances of those PCLP Debentures decrease and, 
consequently, the risk of loss to SBA relating to those Debentures 
decreases.
    Pilot 1 and Pilot 2 were enacted so that PCLP LLRFs would be more 
accurately aligned with the true level of risk associated with the PCLP 
Debentures those LLRFs secure. Pilot 1 reduces the amount a PCLP CDC is 
required to maintain in its LLRF to one percent of the aggregate of the 
outstanding balances of its PCLP Debentures rather than one percent of 
the aggregate of the original face value amounts of those PCLP 
Debentures. Pilot 2 allows a PCLP CDC, which meets certain 
requirements, to maintain its LLRF under an alternative set of LLRF 
requirements. Under Pilot 2, the amount of reserves required to be 
maintained in an LLRF will be determined by a sound risk assessment 
methodology, which must be evaluated and certified by an independent 
auditor.

Pilot 1

    Pilot 1 is a two-year pilot program initiated because existing PCLP 
statutory requirements do not take into account that SBA's risk of loss 
decreases as each PCLP Debenture is paid down. PCLP Debentures are 
issued for either a ten- or twenty-year term and are amortized over the 
duration of the term. As the PCLP CDC makes its semi-annual payments on 
its PCLP Debentures, the outstanding balance is reduced; however, prior 
to Pilot 1 the PCLP CDC could only decrease its LLRF after one of the 
PCLP Debentures secured by its LLRF was completely paid off. Now, in 
accordance with Pilot 1, each PCLP CDC will be permitted to adjust its 
LLRF downward to equal one percent of the sum of the outstanding 
balances of its PCLP Debentures. Congress expects that Pilot 1 will 
encourage additional CDCs to participate in the PCLP.
    In addition, Congress anticipates that Pilot 1 will encourage PCLP 
CDCs to use the funds withdrawn from its LLRF to promote more local 
economic development.

Pilot 2

    Pilot 2 allows certain PCLP CDCs with large LLRFs to elect to 
calculate the appropriate funding of their LLRF using a risk-based 
approach; provided, however, that the minimum amount of the LLRF 
determined by this method equals or exceeds $100,000. A Pilot 2 
participant must use an appropriate and effective process to maintain 
acceptable funding of its LLRF. The American Institute of Certified 
Public Accountants (``AICPA'') and the Federal Financial Institutions 
Examination Council (``FFIEC'') are recognized by SBA to have published 
substantial guidance on the Allowances for Loan and Lease Losses 
(``ALLL'') methodologies and documentation used by the lending 
industry. SBA believes that these methodologies will provide an 
appropriate set of guidelines for independent auditors calculating LLRF 
funding requirements for Pilot 2 participants. In addition, SBA 
recognizes that the United States Department of Treasury, Office of 
Thrift Supervision (``OTS''), has established regulations relating to 
the qualifications of auditors working for institutions subject to OTS 
oversight. SBA believes that those guidelines are also suitable for 
independent auditors making Pilot 2 calculations. Accordingly, SBA 
proposes that a Pilot 2 participant be required to have its LLRF 
determined in accordance with AICPA and FFIEC ALLL methodologies by an 
independent auditor that meets the OTS auditor requirements referenced 
above. Due to the lack of portfolio diversification of CDC loan 
portfolios in terms of region, industry, and asset size, and the 
delegation of additional authority to participants, Congress added 
additional eligibility requirements applicable to Pilot 2 participants. 
For example, a Pilot 2 participant must submit a certification stating 
that its LLRF is sufficient to protect the Federal Government from loss 
due to inadequate LLRFs. The certification must be signed by the head 
of the participating PCLP CDC and its independent auditor and a new 
certification must be submitted for each quarter of Pilot 2 
participation. The proposed regulations would require that the 
certification be adequately supported by methodologies and 
documentation which are consistent with the FFIEC's Policy Statement on 
Allowance for Loan and Lease Losses Methodologies and Documentation for 
Banks and Savings Institutions dated July 2, 2001, as published in 66 
FR 35629, July 6, 2001.
    Perhaps most significantly, a PCLP CDC electing to participate in 
Pilot 2

[[Page 30325]]

would have its loss exposure related to PCLP Debentures increased from 
10 percent to 15 percent for each PCLP Debenture issued while it was 
participating in Pilot 2. Congress determined that this increase might 
be a useful safety measure that could help balance unanticipated risks 
associated with Pilot 2.

Section-by-Section Analysis

    Section 120.847(a) would be amended by creating subsections (a)(1) 
and (a)(2), with (a)(1) adding new definitions applicable to Pilot 1 
and Pilot 2 and (a)(ii) containing the general PCLP CDC LLRF 
information as amended to include reference to Pilot 2 requirements.
    Section 120.847(g) would be amended to incorporate Pilot 1 LLRF 
withdrawal options.
    SBA would amend section 120.847(j) governing insufficient funding 
of the LLRF to add guidance on SBA notification of an LLRF deficiency 
to a Pilot 2 participant.
    Section 120.848 would be redesignated as Sec.  120.849.
    A new Sec.  120.848 would be added to incorporate Pilot 2 
provisions, with the subsections covering various authorities, 
requirements, procedures, and guidelines applicable to Pilot 2. 
Subsection (a) references regulation sections applicable to Pilot 2 and 
states that Pilot 2 participants must reimburse SBA for 15 percent of 
any loss sustained as a result of a default in the payment of principal 
or interest on a PCLP Debenture issued by the PCLP, and guaranteed by 
SBA, during participation in Pilot 2 and 10 percent of any such loss 
related to any of its other PCLP Debentures. Subsection (b) sets forth 
the requirements a PCLP CDC must meet to participate in Pilot 2. In 
addition to the statutory requirements, SBA proposes specific 
guidelines relating to the statutory requirement that a prospective 
Pilot 2 participant has established and is utilizing an appropriate and 
effective process for analyzing the risk of loss associated with its 
portfolio of PCLP loans. Specifically, SBA proposes that LLRF funding 
requirements made under Pilot 2 follow GAAP, AICPA, FFIEC and SBA 
Office of Lender Oversight guidelines for calculating appropriate 
allowances for loan and lease losses. Proposed subsection (b) would 
also provide for (in paragraph (4)) a performance requirement directed 
at a Pilot 2 participant meeting four or more specified risk management 
benchmarks. This is consistent with statutory language. In addition to 
the benchmark indicator, SBA is considering whether the performance 
requirement in the final rule should include that a Pilot 2 
participant's risk rating (as determined by SBA pursuant to published 
guidance) be at a level acceptable to SBA.
    Subsection (c) sets forth the statutory requirements applicable to 
independent auditors used by Pilot 2 participants. The statute requires 
the independent auditor to ``be approved by SBA.'' Under the proposed 
rule, SBA's Bureau of PCLP Oversight would approve the independent 
auditor. SBA also proposes to include in subsection (c) the 
qualifications for independent auditors who will be acceptable to SBA. 
SBA used as a basis for these proposed qualifications the 
qualifications OTS requires for the independent public accountants it 
employs to audit financial statements, applications, or procedures of 
institutions for which the OTS has oversight responsibility. SBA 
believes these qualifications are broad enough to apply usefully to the 
independent auditors who will be carrying out the agreed upon 
procedures applicable to Pilot 2. The subsection also requires that a 
Pilot 2 participant that changes auditors during a Pilot 2 Calendar 
Quarter provide the reasons for the change to the Associate 
Administrator, Office of Lender Oversight (``AA/OLO'') within 30 days 
of the change.
    Subsection (d) states that, to elect to participate in Pilot 2, a 
PCLP CDC must notify the Associate Administrator, Office of Financial 
Assistance (``AA/FA'') and the AA/OLO in writing and include clear 
documentation that it meets the requirements set forth in subsection 
(b) and that its auditor meets the requirements set forth in subsection 
(c).
    Subsection (e) would set forth the statutorily-determined Pilot 2 
participation periods: participation in Pilot 2 must be by calendar 
quarter. Subsection (f) would require a Pilot 2 participant to make any 
necessary contributions to its LLRF necessary to equal the amount 
determined by the independent auditor in accordance with Pilot 2 
requirements or $100,000 if the amount determined by the independent 
auditor is less than $100,000.
    Subsection (g) would set forth procedures related to the 
statutorily-determined Pilot 2 certification requirements applicable to 
the Pilot 2 participant and its auditor, and would permit the Pilot 2 
participant to withdraw funds from its LLRF if the funds exceed Pilot 2 
requirements. The statute states that a Pilot 2 participant which 
decides not to participate in the pilot in the following calendar 
quarter must make a contribution to its LLRF in such an amount as SBA 
may determine. Subsection (g) proposes to allow a Pilot 2 participant 
to adjust its LLRF to meet Pilot 1 requirements within 45 days after 
its Pilot 2 participation or submit to SBA a proposed recontribution 
schedule within 30 days after its Pilot 2 participation. Subsection (g) 
would give SBA the authority to reject a proposed recontribution 
schedule and to require the PCLP CDC to follow an SBA-determined 
recontribution schedule if, in its sole discretion, SBA determines that 
the recontribution schedule submitted by the PCLP CDC would cover the 
exposure related to all of its outstanding PCLP Debentures, or if the 
PCLP CDC fails to submit a recontribution schedule, within the 30-day 
time frame.
    Subsection (h) would provide SBA with the authority to remove a 
PCLP CDC from Pilot 2 participation if that PCLP CDC fails to meet 
Pilot 2 requirements. In such event, subsection (h) would authorize SBA 
to take actions necessary to ensure that the LLRF covers the exposure 
related to all of its outstanding PCLP Debentures, including, but not 
limited to, the right to require the PCLP CDC to follow an SBA-
determined recontribution schedule.
    Finally, subsection (i) would reference the statutorily created 
Bureau of PCLP Oversight. Under the proposed rule, the Bureau may 
review the Pilot 2 participant's process for analyzing the risk of loss 
associated with the Pilot 2 participant's outstanding PCLP Debentures 
(and the underlying PCLP loans) and make a determination as to whether 
the process is consistent with ALLL Methodologies and Documentation and 
in accord with GAAP, AICPA, FFIEC, and SBA Office of Lender Oversight 
guidance/standards. A negative determination could result in SBA 
finding the Pilot 2 participant ineligible to participate in Pilot 2 
under proposed section 120.848(b) or serve as a basis for removal under 
proposed section 120.848(h).

Compliance With Executive Orders 13132, 12988, and 12866, the 
Regulatory Flexibility Act (5 U.S.C. 601-612) and the Paperwork 
Reduction Act (44 U.S.C. Ch. 35)

    This proposed rule would not have substantial direct effects on the 
States, on the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government. Therefore, for the purposes of Executive 
Order 13132, SBA determines that this final rule has no federalism 
implications warranting preparation of a federalism assessment.

[[Page 30326]]

    This proposed rule meets applicable standards set forth in sections 
3(a) and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to 
minimize litigation, eliminate ambiguity, and reduce burden. The 
proposed rule does not have retroactive or preemptive effect.
    The Office of Management and Budget (OMB) has determined that this 
rule constitutes a significant regulatory action under Executive Order 
12866. The statutory amendments to PCLP LLRF requirements (Pilot 1 and 
Pilot 2) revise existing PCLP LLRF requirements and require SBA to 
publish regulations implementing those amendments. The amendments and 
these regulations are intended to: (1) Establish and test alternative 
LLRF concepts that may more accurately reflect the potential risks and 
the potential losses inherent in the PCLP; (2) Ensure LLRF alternatives 
are well founded by incorporating methodologies and standards that 
correspond to the well established principles and standards used by 
commercial lenders for ALLL and that have been approved by the FFIEC 
and the AICPA; (3) Free up PCLP loss reserve capital to enhance PCLP 
CDC operational flexibility and to support additional 504 lending as 
well as other local economic development activities; and (4) Ensure 
each LLRF is adequate to cover the exposure related to all of the 
outstanding PCLP Debentures of the PCLP CDC.
    These objectives are embodied in two-year pilot alternative LLRF 
options which are to be examined and evaluated. Together with the 
existing LLRF requirements, these pilot alternatives represent the most 
reasonable and most viable LLRF alternatives, at least until additional 
longer term program performance data become available and provide the 
basis for a comprehensive broad-based assessment of the PCLP and the 
adequacy of its LLRFs.
    The two pilots are based on reasonable, prudent, and well 
established principles and standards, many of which have been developed 
and tested over the course of several decades by the commercial lending 
industry and have been generally accepted and codified by the Federal 
Financial Institutions Examination Council (FFIEC), whose member 
Federal agencies have various oversight responsibilities over the 
Nation's banking and thrift institutions. However, while these pilot 
concepts are based on sound loss reserve principles and standards, they 
are new to SBA and the PCLP. Consequently, SBA has little empirical 
data on the concepts and can therefore provide only broad and general 
estimates of their costs and benefits. Also, while these alternatives 
will generally reduce the amounts that PCLP CDCs must retain in their 
LLRFs, it should be noted that neither pilot reduces the amount a PCLP 
CDC must reimburse SBA as a result of a default under the PCLP, so the 
pilots' implications for SBA are limited to the risk that a PCLP CDC 
will not have adequate LLRFs or other additional resources with which 
to reimburse the prescribed amount to SBA. (Pilot 2 actually increases 
the amount the PCLP CDC must reimburse SBA as a result of a loss 
relating to the PCLP Debentures issued and guaranteed during the PCLP 
CDC's Pilot 2 participation.) Finally, while SBA recognizes that 
prudent lending and adequate LLRFs sufficient to control program risk 
are integral to the PCLP and its long-term viability, the PCLP is, as 
part of SBA's 504 Program, a zero subsidy loan program. As a result, 
any increased loss rate experienced by SBA under PCLP would translate 
into a change to the 504 Program's subsidy model and ultimately the 
fees paid by the borrowers and the lenders participating in the 
program; it is extremely unlikely that it would affect or increase 
Federal program subsidies because any increased losses are expected to 
be covered by increases in program fees only.
    Pilot 1 allows each PCLP CDC to reduce its LLRF based on the 
decreasing outstanding balance of its PCLP Debentures as opposed to 
maintaining a LLRF equal to one percent of the original amount of all 
of its PCLP Debentures. SBA anticipates that most if not all of the 
PCLP CDCs will take advantage of this option. Following discussions 
with the CDC industry, SBA estimates that the costs incurred by PCLP 
CDCs of adopting Pilot 1 would be relatively insignificant, comprising 
less than $1,000 for each PCLP CDC for minor modifications to internal 
control systems used to calculate LLRF requirements.
    With respect to anticipated benefits of Pilot 1 to PCLP CDCs, most 
(about 95 percent) of the amortized debentures issued under the PCLP 
are for a term of 20 years, with the vast majority of the initial 
debenture payments comprised of interest payments. Since its inception 
in FY 1997, approximately $1.3 billion in debentures have been issued 
under the PCLP, and about $11 million have thus aggregated in all PCLP 
LLRFs. SBA estimates that during the 2 years of Pilot 1, outstanding 
PCLP Debentures will total approximately $1.8 billion, while the 
amounts PCLP CDCs will be required to maintain in their LLRFs under 
Pilot 1 will only increase to approximately $12 million. Without the 
LLRF changes mandated under Pilot 1, SBA estimates that about $16 
million would have otherwise been required to be maintained in the PCLP 
LLRFs. SBA therefore estimates that PCLP CDCs would collectively 
benefit under Pilot 1 with a reduction in PCLP LLRFs of about $4 
million. Following discussions with PCLP CDCs, the consensus was that 
the freed up $4 million in LLRFs would generally be used to expand the 
marketing and delivery of the 504 Program, to support additional 504 
lending, and to increase the local economic develop activities of the 
CDC.
    With respect to the potential costs and risks to SBA of Pilot 1, 
the $4 million reduction in PCLP LLRFs could represent a slight 
increase in the risk to SBA that PCLP LLRFs would be inadequate to 
reimburse SBA for 10 percent of any SBA loss. However, given the 
historical availability of additional assets from which PCLP CDCs could 
reimburse SBA, combined with the extremely low PCLP loss rate of .28 
percent for the program (from program inception), SBA believes that the 
increased risk of non-reimbursement to SBA under Pilot 1 would be 
insignificant. Additionally, SBA estimates that its internal costs for 
modifying the calculation of PCLP LLRF requirements would be 
insignificant, comprising just a few hours of computer programming.
    Pilot 2, which also lasts 2 years, allows certain PCLP CDCs to 
estimate the required level of their LLRF funding using a risk-based 
approach. PCLP CDCs electing this option must have at least $100,000 in 
their respective LLRFs, and they are required to use ALLL methodologies 
and documentation approved by the FFIEC and AICPA, which must in turn 
be certified by a qualified independent auditor meeting auditor 
qualification requirements used by OTS.
    There currently are fewer than 10 PCLP CDCs that meet the 
requirements to participate in Pilot 2. Also, because Pilot 1 will 
reduce PCLP LLRF funding requirements and other CDC program 
enhancements recently instituted by SBA, the SBA believes very few PCLP 
CDCs may elect to participate in Pilot 2 during its 2-year duration. 
Additionally, the uncertainty about the permanence of Pilot 2 and its 
initial development and start up costs may also discourage 
participation. As a result, the aggregate costs and benefits of this 2-
year pilot to the CDC industry are expected to be limited.
    Following discussions with industry representatives, SBA estimates 
that the initial costs to a PCLP CDC for

[[Page 30327]]

developing and instituting Pilot 2's risk based LLRF methodology and 
reporting would be about $8,000. Thereafter, annual costs for 
administering the LLRF would depend on the size and complexity of the 
PCLP CDC's portfolio. However, for a portfolio of about 500-600 PCLP 
loans, which SBA judges to be an average portfolio size for PCLP CDCs 
that might elect this option, SBA estimates that the annual cost would 
be about $75,000. This includes internal costs of about $27,000 for 
periodically assigning and/or reassessing the risk associated with each 
PCLP Debenture, about $10,000 for management oversight and quality 
control of the risk assessment process, about $5,000 for portfolio risk 
management and control, about $30,000 annually to be paid to an 
independent auditor for the ALLL quarterly audit report, and about 
$1,000 for developing and transmitting to SBA the PCLP CDC's required 
certification regarding the adequacy of the LLRF.
    In addition to the costs for developing and maintaining the 
alternative LLRF methodology and reporting, participating PCLP CDCs, as 
noted above, are required to reimburse SBA for 15 percent of any SBA 
loss relating to Debentures issued and guaranteed during Pilot 2 
participation, as opposed to the 10 percent applicable to its other 
PCLP Debentures. With historically low loss rates for the PCLP and 
following discussions with the industry, SBA estimates that the 
additional 5 percent reimbursement would cost a PCLP CDC with a 
portfolio of 500-600 loans less than $5,000 annually.
    With respect to the benefits to a PCLP CDC, Pilot 2 and its risk 
based LLRF methodology represents a new concept for SBA's 504 Program. 
As a result, SBA has no empirical data on how much a PCLP's LLRF could 
be reduced under this concept, so estimating the potential impact and 
benefits is difficult. However, following discussions with the 
industry, and based on preliminary data from simulating the application 
of an ALLL methodology to an existing PCLP portfolio of 500-600 504 
loans, SBA estimates that a PCLP CDC participating in Pilot 2 could 
reduce its LLRFs from the existing LLRF requirement of about $1.8 
million to about $500,000 under Pilot 2, thus freeing up about $1.3 
million from the LLRF for that PCLP CDC. Similar to Pilot 1, these 
funds would generally be used to expand the marketing and delivery of 
the 504 Program, support additional 504 lending, and increase the local 
economic develop activities of the CDC.
    With respect to the potential costs and risks to SBA of Pilot 2, 
SBA believes that the estimated $1.3 million reduction in a typical 
PCLP's LLRF would only marginally increase the risk to SBA that the 
LLRF would be inadequate to cover PCLP CDC reimbursement obligations to 
SBA as required under PCLP. SBA is optimistic that the certification by 
an independent auditor, which meets the proposed requirements and 
applies AICPA and FFIEC standards and methodologies to the ALLRF, will 
help ensure that a LLRF calculated pursuant to Pilot 2 would be 
commensurate with the risk inherent in the PCLP CDC's portfolio. 
Additionally, as with Pilot 1, PCLP CDCs have other assets with which 
to reimburse SBA which, combined with the extremely low PCLP loss rate 
of .28 percent, will further help mitigate the risk that SBA will not 
be reimbursed as required. Finally, Pilot 2 is a 2-year pilot and 
participation is expected to be extremely limited, further controlling 
the risk of loss to SBA. SBA does not foresee any significant 
additional costs to SBA, due to the level of responsibility vested with 
the independent auditor.
    Based on the following analysis, SBA certifies that the proposed 
rule will not have a significant economic impact on a substantial 
number of small entities under the Regulatory Flexibility Act (RFA), 5 
U.S.C. 601. SBA has determined that CDCs fall under the SBA size 
standard for NAICS 522298, All Other Nondepository Credit 
Intermediaries, which establishes $6 million in average annual receipts 
as the maximum annual receipts for small entities. Approximately 5,440 
credit intermediaries fall under that industry classification, about 
4,990 of which are considered small. SBA's CDC Program currently 
comprises approximately 270 CDCs, nearly 30 of which participate in 
PCLP.
    The proposed rule addresses two pilot programs. Pilot 1 allows each 
PCLP CDC to reduce its LLRF based on the decreasing balance of PCLP 
Debentures. Although all 270 CDCs are eligible to participate in the 
PCLP, SBA estimates that only the 30 CDCs that currently participate in 
the PCLP will likely take advantage of this option. Consequently, this 
rule will not impact a substantial number of the small entities.
    Moreover, SBA does not believe that the costs associated with Pilot 
1 will be significant. As noted in the cost benefits analysis, SBA 
estimates that the costs associated with Pilot 1 would be less than 
$1,000 for each PCLP CDC, which is not a significant cost. SBA believes 
that this cost will be offset by the $4 million aggregate reduction or 
a $130,000 per PCLP CDC average reduction in the LLRF requirements. 
Accordingly, SBA certifies that Pilot 1 will not have a significant 
economic impact on a substantial number of small entities.
    Pilot 2 allows certain qualified PCLP CDCs to fund their LLRF using 
a risk-based approach. SBA estimates that less than 10 PCLP CDCs 
currently qualify to participate in Pilot 2, and that less than five 
will take advantage of this option during its 2-year pilot period. SBA 
therefore concludes that this rule will not affect a substantial number 
of small entities. However, as noted above, although the annual costs 
associated with the program would be about $75,000, the reduction in 
the LLRFs requirements for those few PCLP CDCs that do elect to 
participate could be as much as $1.3 million each. Finally, and as also 
noted above, participants in Pilot 2 would be required to reimburse SBA 
for 15 percent of any SBA loss related to a PCLP Debenture issued and 
guaranteed during participation in Pilot 2; the exposure relating to 
its other PCLP Debentures would remain 10 percent. With an historical 
loss rate of .28 percent for PCLP, this additional reimbursement 
obligation is not expected to be significant. As such, SBA certifies 
that Pilot 2 will not have a significant economic impact on a 
substantial number of small entities.
    SBA has determined that the proposed rule, which comprises two 
pilot programs, imposes additional reporting requirements under the 
Paperwork Reduction Act, 44 U.S.C. Ch. 35 (PRA), with respect to Pilot 
2, but no additional recordkeeping requirements for Pilot 1. SBA 
believes that only 5 or less PCLP CDCs will participate in Pilot 2. 
These participating PCLP CDCs and the auditors retained by them would 
be affected by the following information collections (as defined under 
the PRA).

Auditor's Credential Information

    Under proposed Sec.  120.848(c), the auditors retained by the PCLP 
CDCs to conduct the required Pilot 2 LLRF Certification must meet 
certain eligibility requirements established by SBA. The auditors and 
the PCLP CDCs must submit to SBA documentation regarding the auditors' 
credentials and qualifications for SBA's evaluation. We think that the 
total amount of time it would take 5 sets of auditors and PCLP CDCs to 
comply with this reporting requirement would be 30 hours [(5 auditors x 
5 hours) + (5 PCLP CDCs x 1 hour)]. This estimated total is not 
annualized because, based on discussions with the industry on the 
average duration of relationships between CDCs and auditors, we 
anticipate that participants will only

[[Page 30328]]

respond to this collection one time at the beginning of the 2-year 
pilot program.

PCLP CDCs Application to Participate in Pilot 2

    Under proposed Sec.  120.848(b), PCLP CDCs must meet certain 
eligibility requirements established by SBA to participate in Pilot 2. 
The PCLP CDC must submit a letter to SBA notifying the Agency of its 
interest in and qualifications for Pilot 2. We think that the total 
amount of time it would take 5 PCLP CDCs to comply with this reporting 
requirement would be 20 hours (5 PCLP CDCs x 4 hours). This estimated 
total is not annualized because we anticipate that participants will 
only respond to this collection one time at the beginning of the 2-year 
pilot program.

Pilot 2 LLRF Certification

    PCLP CDCs and their independent auditor must submit a Pilot 2 LLRF 
Certification, as defined by the proposed regulations, to SBA at the 
time of the PCLP CDC's application to participate in Pilot 2 and every 
quarter thereafter. SBA estimates that it would take each set of PCLP 
CDCs and auditors 380 hours annually to comply with this quarterly 
reporting requirement [(180 hours for the PCLP CDC) + (200 hours for 
the auditor)]. The total annual hourly burden for 5 sets of PCLP CDCs 
and their auditors would be 1900 hours (380 x 5).
    SBA believes that these 3 information collections are necessary for 
SBA to satisfy its statutory duty to manage and oversee Pilot 2. SBA's 
management functions, as outlined in Public Law 108-232 and implemented 
by the proposed rule, are essential to reasonably protect Pilot 2 and 
the Agency from the risk of waste, fraud, and mismanagement.
    An agency may not conduct or sponsor an information collection 
without prior approval from OMB. Accordingly, we are submitting the 
proposed information collections to OMB for review in accordance with 
the PRA. Comments on the proposed information collection should be sent 
to the Office of Management and Budget, Office of Information and 
Regulatory Affairs, 725 17th Street NW., Washington, DC, 20503, 
Attention: David Rostker, Desk Officer for SBA.

List of Subjects in 13 CFR Part 120

    Loan programs--business, Small businesses, Reporting and 
recordkeeping requirements.

    For the reasons stated in the preamble, SBA proposes to amend 13 
CFR part 120 as follows:

PART 120--BUSINESS LOANS

    1. The authority citation for part 120 continues to read as 
follows:

    Authority: 15 U.S.C. 634(b)(6), and 636(a), 696(3) and 
697(a)(2).

    2. Revise Sec.  120.847 to read as follows:


Sec.  120.847  Requirements for the Loan Loss Reserve Fund.

    (a)(1) Definitions. The following terms have the same meaning where 
they are used in Sec. Sec.  120.845 through 120.848:
    (i) AA/OLO means SBA's Associate Administrator for the Office of 
Lender Oversight.
    (ii) AICPA means the American Institute of Certified Public 
Accountants.
    (iii) ALLL Methodologies and Documentation means methodologies 
followed, and supporting documentation prepared, by a lending 
institution to determine the amounts of the allowance for loan and 
lease losses and the provisions for loan losses for a loan portfolio.
    (iv) FFIEC means the Federal Financial Institutions Examination 
Council.
    (v) GAAP means generally accepted accounting principles.
    (vi) LLRF means the loan loss reserve funds a PCLP CDC maintains in 
accordance with PCLP requirements to secure its loss exposure related 
to all of its outstanding PCLP Debentures.
    (vii) Pilot 1 means the temporary program established pursuant to 
section 508(c)(6)(B) of the SBIA giving authority to a PCLP CDC to 
withdraw from its LLRF, in accordance with the procedures set forth in 
paragraph (g) of this section, any amount in excess of 1 percent of the 
aggregate outstanding balances of all of its outstanding PCLP 
Debentures.
    (viii) Pilot 2 means the temporary program established pursuant to 
section 508(c)(7) of the SBIA which allows certain PCLP CDCs to 
maintain their respective LLRFs in accordance with a calculated risk-
based approach, the terms and conditions of which are set forth in 
Sec.  120.848.
    (ix) Pilot 2 Calendar Quarter means any calendar quarter in which a 
PCLP CDC participates in Pilot 2.
    (x) Pilot 2 Independent Auditor means an auditor which meets the 
requirements set forth in Sec.  120.848 and is providing the auditor 
services related to a PCLP CDC's LLRF as described in that section.
    (xi) Pilot 2 LLRF Certification means a certification, which the 
Executive Director of the PCLP CDC and its Pilot 2 Independent Auditor 
must sign and submit to SBA's Administrator, with copies to the AA/FA 
and AA/OLO, stating:
    (A) The amount the PCLP CDC needs to have in its LLRF to protect 
the Federal Government from risk of loss as calculated in accordance 
with Pilot 2 requirements (accompanied by the documentation necessary 
for SBA to assess the basis of the certification);
    (B) That an amount equal to or greater than the amount established 
in accordance with paragraph (a)(1)(xi)(A) of this section is in the 
PCLP CDC's LLRF and shall remain there until adjustments are made 
pursuant to a new Pilot 2 LLRF Certification (see Sec.  120.848(f)) or 
pursuant to requirements and procedures applicable after a PCLP CDC's 
participation in Pilot 2 ends (see Sec.  120.848(g)); and
    (C) That the PCLP CDC has established and is utilizing an 
appropriate and effective process for analyzing the risk of loss 
associated with its outstanding PCLP Debentures (and the underlying 
PCLP loans) with ALLL Methodologies and Documentation in accord with 
AICPA guidelines, GAAP, and the FFIEC's Policy Statement on Allowance 
for Loan and Lease Losses Methodologies and Documentation for Banks and 
Savings Institutions dated July 2, 2001, as published in 66 FR 35629, 
July 6, 2001.
    (xii) Pilot 2 Participation Period shall mean a full calendar 
quarter as described in Sec.  120.848(e).
    (xiii) SBIA means the Small Business Investment Act of 1958, as 
amended.
    (xiv) Specified Risk Management Benchmarks means, for the purposes 
of Sec.  120.847 and Sec.  120.848, the following rates, as determined 
by SBA:
    (A) Currency rate;
    (B) Delinquency rate;
    (C) Default rate;
    (D) Liquidation rate; and
    (E) Loss rate.
    (2) General. PCLP CDCs must establish and maintain a LLRF (in one 
or multiple accounts) which complies with this section. A PCLP CDC must 
use the LLRF or other funds to cover its Exposure (as defined in 
paragraph (b) of this section) relating to any loss sustained by SBA as 
a result of a default in the payment of principal or interest on a 
Debenture it issued under the PCLP (``PCLP Debenture''). PCLP CDCs must 
coordinate with their Lead SBA Office to ensure that the LLRF is 
properly established, that all necessary documentation is executed and 
delivered by all parties in a timely fashion, and that all required 
deposits are made.

[[Page 30329]]

    (b) PCLP CDC exposure and LLRF deposit requirements. A PCLP CDC's 
``Exposure'' is defined as its reimbursement obligation to SBA with 
respect to default in the payment of any PCLP Debenture. The amount of 
a PCLP CDC's Exposure is 10 percent of any loss (including attorney's 
fees; litigation costs; and care of collateral, appraisal and other 
liquidation costs and expenses) sustained by SBA as a result of a 
default in the payment of principal or interest on a PCLP Debenture; 
provided, however, that a PCLP CDC's Exposure is 15 percent for any 
PCLP Debenture issued during a PCLP CDC's participation in Pilot 2. If 
Pilot 1 and Pilot 2 terminate or otherwise cease to apply to a PCLP 
CDC, then, for each PCLP Debenture a PCLP CDC issues, it must follow 
the applicable transition procedures and timeframes to establish and 
maintain an LLRF equal to one percent of the original principal amount 
(the face amount) of the PCLP Debenture. The amount the PCLP CDC must 
maintain in the LLRF for each PCLP Debenture remains the same even as 
the principal balance of the PCLP Debenture is paid down over time. If 
Pilot 2 terminates or ceases to apply to a PCLP CDC, but Pilot 1 
applies, then the PCLP CDC must establish and maintain an LLRF equal to 
one percent of the outstanding principal balances of its PCLP 
Debentures. (During Pilot 2 participation, Pilot 2 participants would 
not be affected by the termination of Pilot 1.) A PCLP CDC may not 
participate in Pilot 1 and Pilot 2 at the same time.
    (c) Establishing a LLRF. The LLRF must be a deposit account (or 
accounts) with a federally insured depository institution selected by 
the PCLP CDC. A ``deposit account'' is a demand, time, savings, or 
passbook account, including a certificate of deposit (CD) which is 
either uncertificated or, if certificated, non-transferable. A 
``deposit account'' is not an investment account and must not contain 
securities or other investment properties. A deposit account may 
contain only cash and CDs credited to that account. A PCLP CDC may pool 
its deposits for multiple PCLP Debentures in a single account in one 
institution. The LLRF must be segregated from the PCLP CDC's other 
operating accounts. The PCLP CDC is responsible for all fees, costs and 
expenses incurred in connection with establishing, managing and 
maintaining the LLRF, including fees associated with transferring funds 
or early withdrawal of CDs, and related income tax expenses.
    (d) Creating and perfecting a security interest in a LLRF. A PCLP 
CDC must give SBA a first priority, perfected security interest in the 
LLRF to secure the PCLP CDC's obligation to reimburse SBA for the PCLP 
CDC's Exposure under all of its outstanding PCLP Debentures. (If a PCLP 
CDC's LLRF is comprised of multiple deposit accounts, it must give SBA 
this security interest with respect to each such account.) The PCLP CDC 
must grant to SBA the security interest in the LLRF pursuant to a 
security agreement between the PCLP CDC and SBA, and a control 
agreement between the PCLP CDC, SBA, and the applicable depository 
institution. The control agreement must include provisions requiring 
the depository institution to follow SBA instructions regarding 
withdrawal from the account without a requirement for obtaining further 
consent from the PCLP CDC, and must restrict the PCLP CDC's ability to 
make withdrawals from the account without SBA consent. When 
establishing the LLRF, a PCLP CDC must coordinate with its Lead SBA 
Office to execute and deliver the required documentation. The PCLP CDC 
must provide to the Lead SBA Office a fully executed original of the 
security and control agreements. All documents must be satisfactory to 
SBA in both form and substance.
    (e)(1) Schedule for contributions to a LLRF. The PCLP CDC must 
contribute to the LLRF the required deposits for each PCLP Debenture in 
accordance with the following schedule:
    (i) At least 50 percent of the required deposits to the LLRF on or 
about the date that it issues the PCLP Debenture.
    (ii) At least an additional 25 percent of the required deposits to 
the LLRF no later than one year after it issues the PCLP Debenture.
    (iii) Any remainder of the required deposits to the LLRF no later 
than two years after it issues the PCLP Debenture.
    (2) This paragraph (e) does not apply to a PCLP CDC while it is 
participating in Pilot 2 or following the LLRF transition procedures 
applicable to a PCLP CDC after participating in Pilot 2.
    (f) LLRF reporting requirements. Each PCLP CDC must periodically 
report to SBA the amount in the LLRF in a form that will readily 
facilitate reconciliation of the amount maintained in the LLRF with the 
amount required to meet a PCLP CDC's Exposure for its entire portfolio 
of PCLP Debentures. (For Pilot 2 participants, the applicable amount 
will be the amount set forth in the last Pilot 2 LLRF Certification 
submitted by the participant to SBA in accordance with Pilot 2 
requirements.)
    (g) Withdrawal of excess funds. Interest and other funds in the 
LLRF that exceed the required minimums as set forth in paragraph (b) of 
this section, within the time frames set forth in paragraph (e) of this 
section, accrue to the benefit of the PCLP CDC. PCLP CDCs are 
authorized to withdraw excess funds, including interest, from its LLRF 
if such funds exceed the required minimums set forth in paragraph (b) 
of this section. In addition, prior to the expiration of Pilot 1, a 
Pilot 1 participant may withdraw amounts from its LLRF as permitted 
under Pilot 1. The PCLP CDC must forward requests for withdrawals to 
the Lead SBA Office, which will verify the existence and amount of 
excess funds and notify the financial institution to transfer the 
excess funds to the PCLP CDC. A Pilot 2 participant may make 
withdrawals from its LLRF in accordance with Pilot 2 rules.
    (h) Determining SBA loss. When a PCLP CDC has concluded the 
liquidation of a defaulted 504 loan made with the proceeds of a PCLP 
Debenture and has submitted a liquidation wrap-up report to SBA, or 
when SBA otherwise determines that the PCLP CDC has exhausted all 
reasonable collection efforts with respect to that 504 loan, SBA will 
determine the amount of the loss to SBA. SBA will notify the PCLP CDC 
of the amount of its reimbursement obligation to SBA (if any) and will 
explain how SBA calculated the loss.
    (1) If the PCLP CDC agrees with SBA's calculations of the loss, it 
must reimburse SBA an amount equal to its Exposure no later than 30 
days after SBA's notification to the PCLP CDC of the CDC's 
reimbursement obligation.
    (2) If the PCLP CDC disputes SBA's calculations, it must reimburse 
SBA for the amount of the PCLP CDC's Exposure that is not in dispute no 
later than 30 days after SBA's notification to the PCLP CDC of the 
CDC's reimbursement obligation. No later than 30 days after SBA's 
notification, the PCLP CDC may submit to the AA/FA or his or her 
delegate a written appeal of any disagreement regarding the calculation 
of SBA's loss. The PCLP CDC must include with that appeal an 
explanation of its reasons for the disagreement. Upon the AA/FA's final 
decision as to the disputed amount of the loss, the PCLP CDC must 
promptly reimburse SBA the amount of the PCLP CDC's Exposure.
    (i) Reimbursing SBA for loss. A PCLP CDC may use funds in the LLRF 
or other funds to reimburse SBA for the PCLP CDC's Exposure on a 
defaulted PCLP Debenture. If a PCLP CDC does not satisfy the entire 
reimbursement obligation within 30 days after SBA's notification to the 
PCLP CDC of its reimbursement obligation, then SBA

[[Page 30330]]

may cause funds in the LLRF to be transferred to SBA in order to cover 
the PCLP CDC's Exposure, unless the PCLP CDC has filed an appeal under 
paragraph (h)(2) of this section. If the PCLP CDC has filed such an 
appeal, SBA may cause such a transfer of funds to SBA 30 days after, 
and in accordance with, the AA/FA's or his or her delegate's decision. 
If the LLRF does not contain sufficient funds to reimburse SBA for any 
unpaid Exposure with respect to any PCLP Debenture, the PCLP CDC must 
pay SBA the difference within 30 days after demand for payment by SBA.
    (j) Insufficient funding of LLRF. A PCLP CDC must diligently 
monitor the LLRF to ensure that it contains sufficient funds to cover 
its Exposure for its entire portfolio of PCLP Debentures. If, at any 
time, the LLRF does not contain sufficient funds, the PCLP CDC must, 
within 30 days of the earlier of the date it becomes aware of this 
deficiency or the date it receives notification from SBA of this 
deficiency, make additional contributions to the LLRF to make up this 
difference. For Pilot 2 deficiencies, notification will be made by the 
Bureau of PCLP Oversight. The Bureau will so notify Pilot 2 
participants if it determines that:
    (1) The Pilot 2 Independent Auditor failed to calculate the 
portfolio risk and reserve amount using ALLL Methodologies and 
Documentation in accord with GAAP, AICPA, SBA Office of Lender 
Oversight, and FFIEC guidance/standards; and
    (2) The LLRF is insufficient to protect the Federal Government from 
loss due to inadequate LLRF. The notification will state the LLRF 
amount that SBA has determined to be sufficient to protect the Federal 
Government from loss due to inadequate LLRF.


Sec.  120.848  [Redesignated]

    3. Redesignate Sec.  120.848 as Sec.  120.849.
    4. Add a new Sec.  120.848 to read as follows:


Sec.  120.848  Pilot 2.

    (a) General. A PCLP CDC participating in Pilot 2 must establish and 
maintain a LLRF (in one or multiple accounts) which complies with this 
section and the sections of Sec.  120.847 not otherwise expressly noted 
as inapplicable to Pilot 2 participants. Pilot 2 participants must 
reimburse the SBA for 10 percent of any loss sustained by SBA as a 
result of a default in payment of principal or interest on a PCLP 
Debenture; provided however, such participant must reimburse SBA for 15 
percent of any such loss if the PCLP Debenture was issued during the 
PCLP CDC's participation in Pilot 2. Notwithstanding any of the 
provisions of this section, a PCLP CDC may not participate in Pilot 2 
after Pilot 2 terminates.
    (b) Eligibility. A PCLP CDC is eligible to participate in Pilot 2 
if SBA determines that the PCLP CDC:
    (1) Has a LLRF containing at least $100,000;
    (2) Has established and is utilizing an appropriate and effective 
process for analyzing the risk of loss associated with its outstanding 
PCLP Debentures (and the underlying PCLP loans) with ALLL Methodologies 
and Documentation in accord with AICPA guidelines, GAAP, SBA's Office 
of Lender Oversight guidance, and the FFIEC's Policy Statement on 
Allowance for Loan and Lease Losses Methodologies and Documentation for 
Banks and Savings Institutions dated July 2, 2001, as published in 66 
FR 35629, July 6, 2001;
    (3) Has retained an independent auditor that meets the requirements 
set forth in paragraph (c) of this section; and
    (4) Has met or exceeded 4 or more of the Specified Risk Management 
Benchmarks as of the most recent assessment by SBA or SBA has issued a 
waiver for good cause with respect to the requirement of this clause.
    (c) Independent auditor requirements. In order to be eligible to 
participate in Pilot 2, the Bureau of PCLP Oversight must determine 
based on the documentation provided that the auditor:
    (1) Is compensated by the PCLP CDC;
    (2) Is an independent public accountant who:
    (i) Is registered or licensed to practice as a public accountant, 
and is in good standing, under the laws of the state or other political 
subdivision of the United States in which the PCLP CDC's principal 
office is located,
    (ii) Agrees in an engagement letter with the PCLP CDC to provide 
SBA with access to and copies of any work papers, policies, and 
procedures relating to the services performed,
    (iii) Is in compliance with the AICPA Code of Professional Conduct,
    (iv) Meets the independence requirements and interpretations of the 
Securities and Exchange Commission and its staff, and
    (v) Has received, or is enrolled in, a peer review program that 
meets AICPA industry guidelines and standards;
    (3) Has substantial experience calculating portfolio risk and 
reserve amounts using ALLL Methodologies and Documentation in accord 
with AICPA and FFIEC guidance and standards and GAAP;
    (4) Has experience evaluating portfolios comparable to PCLP 504 
Debenture Portfolios; and
    (5) Is otherwise acceptable to SBA. (A Pilot 2 participant which 
changes auditors during a Pilot 2 Calendar Quarter must provide the 
reasons for the change to the AA/OLO within 30 days of the change.)
    (d) Pilot 2 election procedures. A PCLP CDC may elect to 
participate in Pilot 2 by notifying the AA/FA and AA/OLO in writing; 
such notification, which must be received by SBA no less than 10 days 
and no more than 45 days prior to any Pilot 2 participation period for 
which an election is made, must include:
    (1) Clear and complete documentation that the PCLP CDC meets the 
requirements set forth in paragraph (b) of this section;
    (2) Clear and complete documentation that the PCLP CDC's auditor 
meets the requirements set forth in paragraph (c) of this section; and
    (3) A Pilot 2 LLRF Certification.
    (e)(1) Pilot 2 participation periods. Following receipt of written 
confirmation from SBA by the PCLP CDC that it provided the 
documentation required in paragraph (d) of this section, the PCLP CDC's 
Pilot 2 participation period will be the next full calendar quarter and 
any following calendar quarter for which a timely election has been 
made in accordance with paragraph (d) of this section. For purposes of 
this section, full calendar quarters shall mean:
    (i) The period which begins on January 1 and ends on March 31 of 
each year;
    (ii) The period which begins on April 1 and ends on June 30 of each 
year;
    (iii) The period which begins on July 1 and ends on September 30 of 
each year; and
    (iv) The period which begins on October 1 and ends on December 31 
of each year.
    (2) Under no circumstances may a PCLP CDC participate in Pilot 2 
after if it has been statutorily terminated.
    (f) (1) Pilot 2 LLRF contribution requirements. A Pilot 2 
participant must maintain a LLRF in an amount sufficient to cover its 
Exposure as determined by its Pilot 2 Independent Auditor in accordance 
with this section and as set forth in the most recent Pilot 2 LLRF 
Certification; provided, however, that under no circumstances can the 
LLRF contain less than $100,000.
    (2) Pilot 2 LLRF certifications. Pilot 2 LLRF Certifications may be 
made in accordance with Pilot 2 election

[[Page 30331]]

procedures set forth in paragraph (d) of this section; a Pilot 2 
participant must increase the amount of its LLRF, and may reduce the 
amount of its LLRF, as appropriate in order to adjust its LLRF to 
accord with the most recent Pilot 2 LLRF Certification.
    (g) Recontribution requirements after Pilot 2 participation. When a 
PCLP CDC does not participate in Pilot 2 in a calendar quarter 
following Pilot 2 participation, it must adjust the amount of its LLRF 
to equal 1 percent of the sum of outstanding balances of its PCLP 
Debentures either within 45 days after its Pilot 2 participation or in 
accordance with a recontribution schedule submitted by the PCLP CDC and 
approved by SBA. A recontribution schedule must be submitted to SBA in 
writing within 30 days after the end of a PCLP CDC's Pilot 2 
participation and contain documentation necessary to show that the 
schedule would sufficiently cover its Exposure. SBA may disapprove of a 
recontribution schedule if, in SBA's judgment, the schedule would not 
cover the PCLP CDC's Exposure. In that event, SBA will revise the 
recontribution schedule as SBA determines is necessary to cover the 
PCLP CDC's Exposure (SBA-determined recontribution schedule). SBA may 
also require the PCLP CDC to follow an SBA-determined recontribution 
schedule if the PCLP CDC does not submit one within the 30-day time 
frame. An SBA-determined recontribution schedule will be a final agency 
determination.
    (h) Failure by participant to meet Pilot 2 requirements. SBA shall 
have the authority to remove a Pilot 2 participant from Pilot 2 if the 
participant fails to meet one or more Pilot 2 requirements stated in 
Sec.  120.848. In that event, SBA may, among other corrective actions 
it deems necessary to cause the PCLP CDC's LLRF to cover the PCLP CDC's 
Exposure adequately, direct a Pilot 2 participant to follow an SBA-
determined recontribution schedule for its LLRF.
    (1) Bureau of PCLP Oversight. (i) Establishment. There is hereby 
established in the Small Business Administration a bureau to be known 
as the Bureau of PCLP Oversight to carry out such functions as the 
Administrator may from time to time designate or delegate to the Bureau 
of PCLP Oversight (including those described in paragraph (h)(1)(ii) of 
this section).
    (ii) Pilot 2. The Bureau may review the Pilot 2 participant's 
process for analyzing the risk of loss associated with its portfolio of 
PCLP loans or for grading each PCLP loan made by the pilot 2 
participant and make a determination as to whether the process is 
consistent with ALLL Methodologies and Documentation and in accord with 
GAAP, AICPA, SBA Office of Lender Oversight and FFIEC guidance/
standards. A negative determination may result in SBA finding the Pilot 
2 participant ineligible to participate in Pilot 2 under Sec.  
120.848(b). It may also serve as a basis for program removal under 
Sec.  120.848(h).
    (2) [Reserved].

    Dated: February 3, 2006.
Hector V. Barreto,
Administrator.
 [FR Doc. E6-8039 Filed 5-25-06; 8:45 am]
BILLING CODE 8025-01-P