SBA Lender Risk Rating System, 24053-24057 [2014-09642]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 79, Number 82 (Tuesday, April 29, 2014)]
[Notices]
[Pages 24053-24057]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-09642]


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SMALL BUSINESS ADMINISTRATION

[Docket No: SBA-2014-0003]


SBA Lender Risk Rating System

AGENCY: Small Business Administration.

ACTION: Notice of revised Risk Rating System; request for comments.

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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: https://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 https://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 https://
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.

[[Page 24054]]


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

[[Page 24055]]

and aggregates all available trade accounts on a monthly basis for its 
entire global database of commercial entities.
    In addition, two new components in the redeveloped model utilize 
macroeconomic data. Macro-economic components add a new dimension to 
the model and improve the overall predictive ability. The contributions 
of more than 20 such variables were analyzed. State Housing Price Index 
and Unemployment Rate were selected based on the level and reliability 
of their contributions. These two new components add predictive value 
to the Risk Rating model.
    The redeveloped Risk Rating is one of the initial steps in 
implementing SBA's new oversight framework. In the future, SBA plans to 
use the Risk Rating in conjunction with other performance benchmarks 
that are currently under development. These new performance benchmarks 
will be used to assess SBA Lenders in multiple categories. For 7(a) 
Lenders, the categories are expected to include performance, asset 
management, regulatory compliance, risk management, and other relevant 
risk related items; the categories for CDCs are expected to include 
solvency, management, asset quality and servicing, regulatory 
compliance, and technical issues and mission. SBA will provide more 
information on the new performance benchmarks in the future.

III. Request for Comments

    This notice provides program participants and other parties with an 
explanation of the components and a description of other modeling 
enhancements. SBA is soliciting comments on all aspects of this notice, 
including but not limited to the components and enhancements. These 
changes will be effective upon publication of this notice, and will be 
incorporated in the Risk Rating Lender Portal update in May, for the 
quarter ending March 31, 2014.

IV. Text of the SBA Lender Risk Rating System

(A) Overview

    Under SBA's Risk Rating System, SBA assigns all SBA Lenders a 
composite Risk Rating. The composite rating reflects SBA's assessment 
of the SBA Lender's potential risk. It is based on the loan-level 
probability of purchase over the next 12 months, as calculated by SBA.
    The Risk Rating System assigns each SBA-guaranteed loan a projected 
purchase rate using a unique set of components that SBA has determined 
to be predictive for that type of loan (see further detail below). Each 
individual loan-level PPR is then multiplied by the total outstanding 
balance of the loan in order to approximate the SBA Lender's total 
exposure for its SBA loan portfolio. The sum of all of those values is 
an estimation of the total default dollars for the SBA portfolio of the 
SBA Lender in the next 12 months. That number is then divided by the 
total outstanding balances of all loans in the above calculation to 
obtain the SBA Lender's overall PPR. SBA then assigns a composite 
rating of 1 to 5 based on the SBA Lender's overall PPR with 
geometrically sequenced category thresholds. Geometrically sequenced 
categories contain thresholds that are a multiple of the prior 
category. The category boundaries represent a doubling of the prior 
category (with the exception of the ``zero'' threshold). Geometric 
categorizations aim to delineate a non-linear distribution more evenly.
    SBA updates the Lender Risk Ratings on a quarterly basis, using 
refreshed SBA Lender data. SBA generally does not intend to use the 
Risk Ratings as the sole basis for taking enforcement actions against 
SBA Lenders. The primary purpose is to focus SBA's oversight resources 
on those SBA Lenders whose portfolio performance or other lender-
specific risk-related factors demonstrate a need for further review and 
evaluation by SBA. All SBA Lenders have on-line access to their Risk 
Ratings and the loan-level components utilized to generate each loan's 
PPR. Information on gaining access to the Lender Portal is available at 
72 FR 27611, 27619 (May 16, 2007) and on the Portal log-on page at 
https://mi.dnb.com/PDPSBA/PDPLogin.aspx.

(B) Segmentation

    SBA's Risk Rating System uses a segmentation approach to calculate 
the PPR of each loan in an SBA Lender's SBA portfolio. The loan 
segments for the 7(a) Program are as follows:
    1. Revolver-type loans in current payment status,
    2. Revolver-type loans in non-current payment status,
    3. Fixed-end loans in current payment status with an outstanding 
balance greater than or equal to $350,000,
    4. Fixed-end loans in current payment status with an outstanding 
balance less than $350,000, and
    5. Fixed-end loans in non-current payment status.
    The loan segments for the CDC Program (also referred to as the 504 
Program) are:
    1. Loans in current payment status, and
    2. Loans in non-current payment status.
    A loan's PPR is calculated based on a combination of components 
that is uniquely predictive for the loans in that segment. The 
components used in each segment are as follows:

    7(a) Segment 1--Revolver-type loans in current payment status:

(a) Percent of Accounts More Than 30 Days Past Due
(b) Number of Trade Accounts
(c) Current Small Business Predictive Score (SBPS)
(d) Months on Book (MOB)
(e) Outstanding Loan Balance
(f) Loan Term
(g) Average State-level Unemployment Rate

    7(a) Segment 2--Revolver-type loans in non-current payment status:

(a) Percent of Accounts More Than 30 Days Past Due
(b) Current SBPS
(c) MOB
(d) Outstanding Loan Balance
(e) Loan Term
(f) Loan Status

    7(a) Segment 3--Fixed-end loans in current payment status with an 
outstanding balance greater than or equal to $350,000:

(a) Percent of Current Accounts
(b) Percent of Accounts One or More Days Past Due
(c) Number of Trade Accounts
(d) Current SBPS
(e) MOB
(f) Average State-level Unemployment Rate

    7(a) Segment 4--Fixed-end loans in current payment status with an 
outstanding balance less than $350,000:

(a) Number of Trade Accounts
(b) Percent of Accounts More Than 30 Days Past Due
(c) Current SBPS
(d) MOB
(e) Gross Approved Amount
(f) Loan Term
(g) Average State-level Unemployment Rate

    7(a) Segment 5--Fixed-end loans in non-current payment status:

(a) Number of Trade Accounts
(b) Percent of Accounts More Than 30 Days Past Due
(c) Current SBPS
(d) MOB
(e) Gross Approved Amount
(f) Loan Term
(g) Loan Status
(h) Average State-level Unemployment Rate


[[Page 24056]]


    504 Segment 1--Loans in current payment status:

(a) Percent of Current Accounts
(b) Average Percent of Dollars More Than 30 Days Past Due
(c) Percent of Accounts One or More Days Past Due
(d) Number of Trade Accounts
(e) Current SBPS
(f) MOB
(g) State Housing Price Index

    504 Segment 2--Loans in non-current payment status:

(a) Business Age
(b) Number of Trade Accounts
(c) Current SBPS
(d) MOB
(e) Loan Status
(f) State Housing Price Index

    The components were selected through statistical analysis using 
step-wise logistic regression to identify the combination of variables 
that are the most predictive for each segment of loans. The new model 
is ``multivariate,'' meaning that an SBA Lender's PPR (and thus its 
Risk Rating) is based on a combination of all components in the model. 
Each of the components is described in more detail in the Rating 
Components section below.

(C) Rating Components

    SBA derives components from three types of data sources to 
calculate a loan's PPR: SBA loan data, D&B Borrower data, and 
macroeconomic data. The first category, made up of components (i) 
through (vi) below, includes detailed loan/borrower level information 
from SBA's database. The second category, which includes components 
(vii) through (xii) below, is information on the small business 
borrower from D&B's trade database. The third category, components 
(xiii) and (xiv) below, includes state level unemployment and housing 
price macroeconomic data. Each of the components is defined in detail 
below.
    (i) Loan Status: The Loan Status component captures the payment 
status of loans as of the rating date. If delinquent, this component 
indicates the delinquency ``bucket'' (e.g., 30 days past due, 60 days 
past due, etc.) at the time of rating. Other status values include 
whether the loan is in a deferment. A greater number of days past due 
contributes to a higher purchase risk.
    (ii) Loan Term: The Loan Term is the length of loan repayment 
period at origination. Loan Term is measured in months and purchase 
risk increases as the repayment term increases.
    (iii) Months on Book (MOB): The MOB is the number of months between 
the rating date and the date of the loan disbursement, up to a maximum 
of 120 months. MOB is based on the date of first disbursement. The 
purchase risk associated with MOB Risk level is ``U''-shaped: loans at 
either end of the spectrum (very low or very high MOB) have the highest 
purchase risk.
    (iv) Outstanding Loan Balance: The Outstanding Loan Balance is the 
outstanding gross loan balance at the time of the rating date. This 
component is only used for revolver-type accounts that are currently in 
active status. The purchase risk associated with Outstanding Loan 
Balance has an inverted ``U'' shape. For revolvers, purchase risk was 
found to be consistently lowest for very small or very large balances 
and higher for moderate-sized balances.
    (v) Gross Approved Amount: The Gross Approved Amount is the total 
dollar amount of the loan at origination. A lower Gross Approval Amount 
is associated with a higher purchase risk.
    (vi) SBPS: The SBPS is a portfolio management credit score based 
upon a borrower's business credit report and principal's consumer 
credit report and is updated quarterly. SBPS is a proprietary 
calculation provided by Dun & Bradstreet, under contract with SBA, and 
is compatible with FICO's ``Liquid Credit'' origination score. This 
component provides an indication of the relative credit worthiness of a 
given borrower. A higher SBPS is associated with a lower purchase risk.
    (vii) Percent of Current Accounts: The Percent of Current Accounts 
is the percentage of the Borrower's trade accounts, as reported to D&B, 
that have been current over the past 24 months. It is a percentage that 
results from dividing the total number of accounts that have not been 
delinquent in the past 24 months by the total number of active accounts 
associated with a borrower. Higher values of this attribute are 
associated with lower purchase risk.
    (viii) Percent of Accounts 30 Days or More Days Past Due: The 
Percent of Accounts 30 Days or More Past Due is calculated using data 
from the D&B detail trade database for the last four months. This 
percentage results from dividing the total number of accounts which 
have been 30 or more days delinquent in the past four months by the 
total number of active accounts associated with a borrower. A higher 
value for this attribute is associated with a higher purchase risk.
    (ix) Percent of Accounts One or More Days Past Due: The Percent of 
Accounts One or More Days Past Due is calculated using data from the 
D&B detail trade database for the last four months. This percentage 
results from dividing the total number of accounts which have been one 
or more days delinquent in the past four months by the total number of 
active accounts associated with a borrower. A higher value for this 
attribute is associated with a higher purchase risk.
    (x) Average Percent of Dollars More Than 30 Days Past Due: The 
Average Percent of Dollars More Than 30 Days Past Due uses data for the 
last three months of trade history in the D&B database. This attribute 
is the ratio of the total dollars more than 30 days past due divided by 
the total dollars across a 3-month interval. A higher value for this 
attribute is associated with a higher purchase risk.
    (xi) Number of Trade Accounts: The Number of Trade Accounts is the 
number of the Borrower's trade accounts on the D&B database in the last 
four months. A higher number of trade accounts is associated with a 
lower purchase risk.
    (xii) Business Age: Business Age is the number of years the 
borrower has been operating. Age is based on data in the D&B database 
and is calculated as the difference between the current date and one of 
the following: The date of the most recent change of management 
control, if available, otherwise defaulting to the inception year of 
the business, if available, or to the first year the business was 
present on the D&B archive. A lower age contributes to a higher 
purchase risk.
    (xiii) Average State-level Unemployment Rate: The Average State-
level Unemployment Rate is the ratio of unemployed to the civilian 
labor force in the borrower's State, expressed as a percent. The source 
is Bureau of Labor Statistics (BLS), Local Area Unemployment Statistics 
Database. The borrower's state is identified through borrower's address 
fields in the SBA's database. The unemployment rate is extracted 
directly from BLS reporting, which is updated monthly. A higher 
unemployment rate in the borrower's state contributes to a higher 
purchase risk.
    (xiv) State Housing Price Index (HPI): The State HPI is a broad 
measure of the movement in single-family house prices in the borrower's 
State. It is seasonally adjusted based on transactions involving 
conventional mortgages purchased or securitized by Fannie Mae or 
Freddie Mac and updated quarterly. The source is the Federal Housing 
Finance Agency. A higher HPI is associated with a lower purchase risk.

[[Page 24057]]

(D) Lender Risk Rating

    The SBA Lender Risk Rating (LRR) is a measure of predicted 
performance over the next 12 months. SBA uses its Risk Rating model to 
calculate an expected purchase rate and assign a composite rating of 1 
to 5 to each SBA Lender. SBA may make adjustments to the composite 
rating based on results of reviews, third party information on an SBA 
Lender's operations, portfolio trends, and other information that could 
impact an SBA Lender's risk profile. (See section E ``Overriding 
Factors'' for further detail.) 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. Rating categories 2, 3, and 4 
provide granularity for moderate levels of risk and the corresponding 
levels of necessary oversight.

(E) Overriding Factors

    As with prior LRR models, the redeveloped Risk Rating System allows 
for consideration of additional factors. The occurrence of these 
factors may lead SBA to conclude that an individual SBA Lender's 
composite rating, as calculated by the Risk Rating model, is not fully 
reflective of its true risk. Therefore, the Risk Rating System provides 
for the consideration of overriding factors, which may only apply to a 
particular SBA Lender or group of SBA Lenders, and permit SBA to adjust 
an SBA Lender's calculated composite rating. The allowance of 
overriding factors in helping determine an SBA Lender's Risk Rating 
enables SBA to use key risk factors that are not necessarily applicable 
to all SBA Lenders, but indicate a greater or lower level of risk from 
a particular SBA Lender than that which the calculated rating provides.
    Overriding factors may result from SBA Lenders' risk-based reviews/
examinations and evaluations. SBA routinely conducts reviews of larger 
SBA Lenders, performs safety and soundness examinations of SBA Small 
Business Lending Companies (SBLCs) and Non-Federally Regulated Lenders 
(NFRLs), and uses certain evaluation measures for other SBA Lenders. 
Examples of other overriding factors that may be considered include, 
but are not limited to: enforcement or other actions of regulators or 
other authorities, including, but not limited to, Cease & Desist orders 
by, or related agreements with, federal financial regulators; capital 
adequacy levels not in conformity with federal financial regulators; 
secondary market issues and concerns; 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; net 
yield rate significantly worse than average; violation of SBA Loan 
Program Requirements; inadequate, incomplete, or untimely reporting to 
SBA; and inaccurate submission of required fees or amounts due SBA or 
the federal government.
    In conclusion, industry best practices and changes in the SBA 
portfolio, programs, and available data necessitate that SBA's Risk 
Rating model be periodically redeveloped. This notice marks the second 
redevelopment of SBA's Risk Rating model. In addition to the 
redevelopment, SBA has and will continue to perform annual validation 
testing on the calculated composite Risk Ratings, and will further 
refine the model as necessary to maintain or possibly improve the 
predictiveness of its risk scoring.

    Authority:  15 U.S.C. 633(b)(3); 15 U.S.C. 634(b)(6) and (7); 15 
U.S.C. 687(f); and 13 CFR 120.1015.

Maria Contreras-Sweet,
Administrator.
[FR Doc. 2014-09642 Filed 4-28-14; 8:45 am]
BILLING CODE 8025-01-P