80 FR 38499 - Small Business Investment Companies-Request for Comments on Credit and Risk Management Issues

SMALL BUSINESS ADMINISTRATION

Federal Register Volume 80, Issue 128 (July 6, 2015)

Page Range		38499-38500
FR Document		2015-16430

The Small Business Administration (SBA) has identified two issues that potentially affect SBA's ability to make recoveries from a small business investment company (SBIC) that performs poorly and poses a credit risk to SBA. The Agency seeks public input on how SBA should address its credit concerns regarding these two issues: SBICs with unsecured lines of credit, and the determination of ``equity capital investments'' when calculating an SBIC's capital impairment percentage.

Federal Register, Volume 80 Issue 128 (Monday, July 6, 2015)

[Federal Register Volume 80, Number 128 (Monday, July 6, 2015)]
[Notices]
[Pages 38499-38500]
From the Federal Register Online [www.thefederalregister.org]
[FR Doc No: 2015-16430]

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SMALL BUSINESS ADMINISTRATION

[Docket ID No. SBA-2015-0009]

Small Business Investment Companies--Request for Comments on
Credit and Risk Management Issues

AGENCY: U.S. Small Business Administration.

ACTION: Notice and request for comments.

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SUMMARY: The Small Business Administration (SBA) has identified two
issues that potentially affect SBA's ability to make recoveries from a
small business investment company (SBIC) that performs poorly and poses
a credit risk to SBA. The Agency seeks public input on how SBA should
address its credit concerns regarding these two issues: SBICs with
unsecured lines of credit, and the determination of ``equity capital
investments'' when calculating an SBIC's capital impairment percentage.

DATES: Comments must be received on or before September 4, 2015.

ADDRESSES: Submit your comments, identified by Docket ID No. SBA-2015-
0009, at www.regulations.gov. Comments may only be submitted at this
web address; follow the instructions on the Web site for submitting
comments. All comments received will be included in the public docket
without change and will be available online at www.regulations.gov. All
submissions, including attachments and other supporting materials, will
become part of the public record and subject to public disclosure.
Sensitive information and information that you consider to be
Confidential Business Information or otherwise protected should not be
included. Submissions will not be edited to remove any identifying or
contact information.

FOR FURTHER INFORMATION CONTACT: Lyn Womack, Office of Investment and
Innovation, 409 Third St. SW., Washington, DC 20416, (202) 205-2416.

SUPPLEMENTARY INFORMATION:

I. Background Information

The SBIC Program was established under the Small Business
Investment Act of 1958. 15 U.S.C. 661 et seq. (the ``Act''). SBICs are
privately owned and professionally managed investment funds, licensed
and regulated by SBA, that use privately-raised capital to make equity
and debt investments in qualifying small businesses. SBICs may be
leveraged or non-leveraged. Leveraged SBICs use privately raised
capital plus funds borrowed by issuing debentures guaranteed by SBA to
make such qualifying investments. Only SBICs with outstanding debenture
leverage pose a credit risk to SBA, and SBA's request for input in this
notice is limited to this type of SBIC. SBA does not anticipate any
changes to the regulations as a result of this notice, but will
consider changes to the policy guidance that interprets the
regulations.
SBICs are governed by Title 13, Part 107 in the Code of Federal
Regulations (13 CFR part 107) which may be found at www.thefederalregister.org/fdsys/pkg/CFR-2014-title13-vol1/xml/CFR-2014-title13-vol1-part107.xml. SBA
also issues supplemental guidance through various publications which
may be found at www.sba.gov/sbicpolicy.

II. Areas of Concern

SBA is seeking public input on the following areas of concern:
1. Unsecured Lines of Credit. The Act provides that SBA ``(1) shall
not permit a licensee having outstanding leverage to incur third party
debt that would create or contribute to an unreasonable risk of default
or loss to the Federal Government; and (2) shall permit such licensees
to incur third party debt only on such terms and subject to such
conditions as may be established by the Administrator, by regulation or
otherwise.'' 15 U.S.C. 683(c). Pursuant to 13 CFR 107.550, a leveraged
SBIC must obtain SBA's prior written approval before it incurs any
secured third-party debt. In practice, SBA rarely approves secured
third-party debt facilities because the collateral for such debt
consists of the same assets SBA relies on to protect its creditor
position. SBA approval is not required for unsecured third-party debt,
though the Agency may review the related loan agreement(s) in
connection with its oversight, including examinations, of the SBIC.
Leveraged SBICs commonly use unsecured lines of credit. Although
permitted by the regulations without SBA prior approval, all such
credit facilities pose a potential credit risk to SBA because, with
certain limited exceptions set forth under 13 CFR 107.560, the Agency
is subordinated to the first $10 million of such debt. Furthermore, SBA
is concerned that many such credit facilities contain certain
provisions that may increase SBA's credit risk. SBA is specifically
concerned about provisions that, upon a default (which may include
events other than a payment default; for example, failure by more than
a certain number of investors in the SBIC to fund a capital call within
a stated period), allow a lender to make a capital call directly on the
SBIC's investors and use the proceeds to repay the line of credit.
Similarly, SBA is concerned about provisions that permit a lender to
compel the SBIC's General Partner to make a capital call, together with
remedies including specific performance and/or injunctive relief. If an
SBIC defaults on its leverage and is transferred by SBA to a
liquidation status in accordance with the SBIC's leverage terms, the
SBIC's remaining commitments are a significant source of capital that
SBA relies upon for repayment of the SBIC's leverage. However, such
commitments will not be available to SBA if they have already been
called to satisfy a default under the SBIC's unsecured credit facility.
SBA has also observed that some SBICs use these lines on a short-term
basis to fund investments, while others maintain outstanding balances
on a longer-term basis for working capital or other purposes.
SBA is seeking comments as to how the Agency can best address its
credit concerns while continuing to permit SBICs to utilize unsecured
lines of credit. Among other things, SBA is seeking input from the
public with regard to the following questions:
(a) What credit concerns should SBA have regarding an SBIC's credit
facility if the maximum extension of credit under such a facility is in
the amount of $10 million or less?
(b) How frequently, or what percent of total dollars or lines of
credit, do lenders provide unsecured credit to SBICs in an amount above
$10 million?
(c) What are the typical maturity dates for such credit facilities
(e.g., 12 month term) and are they routinely extended?

[[Page 38500]]

(d) What is the average balance and settlement of credit lines
extended to SBICs?
(e) Based on SBA's view that short-term borrowings pose a lower
credit risk, what restrictions, if any, should SBA consider placing on
the length of time a balance may remain outstanding on an unsecured
line?
(f) Should SBA permit such facilities only during time periods of
an SBIC's lifecycle when the risk to SBA is lower, for example during
the early years of the SBIC's life or before additional leverage is
drawn? If so, what considerations should SBA take into account in
determining the timing and duration of these periods?
(g) Are there certain provisions in unsecured loan agreements that
SBA should be especially concerned about with respect to credit risk
(e.g., remedies available to a lender such as specific performance or
injunctive relief) and how should SBA deal with those provisions?
(h) What type of credit risk policies would be most effective in
managing SBA's credit risk with respect to unsecured lines of credit?
2. Determination of Equity Capital Investments (ECI) in the
calculation of an SBIC's maximum allowable Capital Impairment
Percentage (CIP). 13 CFR 107.1830(c) defines the maximum allowable CIP
for a leveraged SBIC that is not an Early Stage SBIC. If an SBIC
exceeds its maximum allowable CIP, it constitutes a condition of
Capital Impairment, which is an event of default under the terms of its
leverage. 13 CFR 107.1810(f)(5). An SBIC's maximum allowable CIP
depends on two variables: (1) the percentage at cost of ECI in the
SBIC's portfolio, and (2) the ratio of outstanding leverage to
Leverageable Capital.
Under 13 CFR 107.50, ECI generally means investments in a small
business in the form of common or preferred stock, limited partnership
interests, options, warrants, or similar equity instruments, including
subordinated debt with equity features if such debt provides only for
interest payments contingent upon and limited to the extent of
earnings. Further, Leverageable Capital means, as more fully described
in 13 CFR 107.50, paid-in capital of an SBIC.
SBA's regulations permit a higher maximum allowable CIP when the
percentage of ECI in an SBIC's portfolio is higher in recognition that
equity-type investment strategies are inherently riskier and frequently
require a longer holding period relative to debt investments before a
successful exit can be achieved.
SBA has observed over the last few years that SBICs seeking to
avoid Capital Impairment have converted non-ECI investments to ECI
solely for the purpose of attaining an increase in maximum allowable
CIP. For example, an SBIC can convert a loan into equity, which would
cause the investment to then qualify as ECI. Depending on the
circumstances of the SBIC, the converted security could cause the
SBIC's maximum allowable CIP to increase and artificially forestall the
SBIC from having a condition of Capital Impairment, which creates risk
to taxpayers.
SBA has also observed the deteriorating performance of portfolio
companies held in a particular SBIC can likewise result in an SBIC's
maximum allowable CIP increasing. Using the example in the prior
paragraph, the loan could have been converted to equity as a result of
a distressed restructuring of the company. In either case, the
increased ECI was not the result of the SBIC making an ECI investment
from the outset, but instead converting non-ECI based on the impairment
status of the SBIC or the deteriorated status of a small concern.
SBA aims to prevent conversions specifically and solely intended to
artificially increase maximum allowable CIP, because such conversions
result in the SBIC having a reduced collateral position in the
portfolio company at a time when that collateral may be critical for
SBA to obtain a recovery from the SBIC. However, in considering any
policy changes to managing its credit risk with respect to ECI, SBA
does not seek to create unnecessary burdens for SBICs who may convert
an investment to ECI for business reasons unrelated to solely avoiding
Capital Impairment (e.g., the exercise of conversion rights prior to a
planned IPO). Accordingly, the Agency welcomes comments from the public
on how to achieve this objective. Comments may be general in nature
and/or answer the following questions:
(a) Other than the examples provided in this notice, what
transactions or circumstances can result in an original non-ECI
becoming qualified as an ECI?
(b) What specific factors should SBA consider in determining that
investments are disqualified as ECI for the purposes of calculating an
SBIC's maximum allowable CIP?
(c) Without creating an undue reporting burden on SBICs, how can
SBA differentiate between investments converted for legitimate business
reasons and those converted for other reasons, including solely to
inflate total ECI in the SBIC's portfolio?

Authority: 15 U.S.C. 681.

Javier Saade,
Associate Administrator for Investment and Innovation.
[FR Doc. 2015-16430 Filed 7-2-15; 8:45 am]
BILLING CODE 8025-01-P

Federal Register / Vol. 80, No. 128 / Monday, July 6, 2015 / Notices 38499

Percent Confidential Business Information or unsecured third-party debt, though the
otherwise protected should not be Agency may review the related loan
For Physical Damage: included. Submissions will not be agreement(s) in connection with its
Non-Profit Organizations 2.625 edited to remove any identifying or oversight, including examinations, of
With Credit Available contact information. the SBIC.
Elsewhere. Leveraged SBICs commonly use
Non-Profit Organizations 2.625 FOR FURTHER INFORMATION CONTACT: Lyn
Womack, Office of Investment and unsecured lines of credit. Although
Without Credit Available
Innovation, 409 Third St. SW., permitted by the regulations without
Elsewhere.
For Economic Injury: Washington, DC 20416, (202) 205–2416. SBA prior approval, all such credit
Non-Profit Organizations 2.625 facilities pose a potential credit risk to
SUPPLEMENTARY INFORMATION:
Without Credit Available SBA because, with certain limited
Elsewhere. I. Background Information exceptions set forth under 13 CFR
107.560, the Agency is subordinated to
The SBIC Program was established
The number assigned to this disaster the first $10 million of such debt.
under the Small Business Investment
for physical damage is 14359B and for Furthermore, SBA is concerned that
Act of 1958. 15 U.S.C. 661 et seq. (the
economic injury is 14360B. many such credit facilities contain
‘‘Act’’). SBICs are privately owned and
(Catalog of Federal Domestic Assistance certain provisions that may increase
Numbers 59002 and 59008) professionally managed investment
SBA’s credit risk. SBA is specifically
funds, licensed and regulated by SBA, concerned about provisions that, upon a
James E. Rivera, that use privately-raised capital to make default (which may include events other
Associate Administratorfor Disaster equity and debt investments in
Assistance. than a payment default; for example,
qualifying small businesses. SBICs may failure by more than a certain number
[FR Doc. 2015–16428 Filed 7–2–15; 8:45 am] be leveraged or non-leveraged. of investors in the SBIC to fund a capital
BILLING CODE 8025–01–P Leveraged SBICs use privately raised call within a stated period), allow a
capital plus funds borrowed by issuing lender to make a capital call directly on
debentures guaranteed by SBA to make the SBIC’s investors and use the
SMALL BUSINESS ADMINISTRATION such qualifying investments. Only proceeds to repay the line of credit.
[Docket ID No. SBA–2015–0009] SBICs with outstanding debenture Similarly, SBA is concerned about
leverage pose a credit risk to SBA, and provisions that permit a lender to
Small Business Investment SBA’s request for input in this notice is compel the SBIC’s General Partner to
Companies—Request for Comments limited to this type of SBIC. SBA does make a capital call, together with
on Credit and Risk Management Issues not anticipate any changes to the remedies including specific
regulations as a result of this notice, but performance and/or injunctive relief. If
AGENCY: U.S. Small Business will consider changes to the policy
Administration. an SBIC defaults on its leverage and is
guidance that interprets the regulations. transferred by SBA to a liquidation
ACTION: Notice and request for SBICs are governed by Title 13, Part status in accordance with the SBIC’s
comments. 107 in the Code of Federal Regulations leverage terms, the SBIC’s remaining
SUMMARY: The Small Business (13 CFR part 107) which may be found commitments are a significant source of
Administration (SBA) has identified two at www.gpo.gov/fdsys/pkg/CFR-2014- capital that SBA relies upon for
issues that potentially affect SBA’s title13-vol1/xml/CFR-2014-title13-vol1- repayment of the SBIC’s leverage.
ability to make recoveries from a small part107.xml. SBA also issues However, such commitments will not be
business investment company (SBIC) supplemental guidance through various available to SBA if they have already
that performs poorly and poses a credit publications which may be found at been called to satisfy a default under the
risk to SBA. The Agency seeks public www.sba.gov/sbicpolicy. SBIC’s unsecured credit facility. SBA
input on how SBA should address its II. Areas of Concern has also observed that some SBICs use
credit concerns regarding these two these lines on a short-term basis to fund
SBA is seeking public input on the investments, while others maintain
issues: SBICs with unsecured lines of
following areas of concern: outstanding balances on a longer-term
credit, and the determination of ‘‘equity
1. Unsecured Lines of Credit. The Act basis for working capital or other
capital investments’’ when calculating
provides that SBA ‘‘(1) shall not permit purposes.
an SBIC’s capital impairment
a licensee having outstanding leverage SBA is seeking comments as to how
percentage.
to incur third party debt that would the Agency can best address its credit
DATES: Comments must be received on create or contribute to an unreasonable concerns while continuing to permit
or before September 4, 2015. risk of default or loss to the Federal SBICs to utilize unsecured lines of
ADDRESSES: Submit your comments, Government; and (2) shall permit such credit. Among other things, SBA is
identified by Docket ID No. SBA–2015– licensees to incur third party debt only seeking input from the public with
0009, at www.regulations.gov. on such terms and subject to such regard to the following questions:
Comments may only be submitted at conditions as may be established by the (a) What credit concerns should SBA
this web address; follow the instructions Administrator, by regulation or have regarding an SBIC’s credit facility
on the Web site for submitting otherwise.’’ 15 U.S.C. 683(c). Pursuant if the maximum extension of credit
comments. All comments received will to 13 CFR 107.550, a leveraged SBIC under such a facility is in the amount
be included in the public docket must obtain SBA’s prior written of $10 million or less?
Lhorne on DSK7TPTVN1PROD with NOTICES

without change and will be available approval before it incurs any secured (b) How frequently, or what percent of
online at www.regulations.gov. All third-party debt. In practice, SBA rarely total dollars or lines of credit, do
submissions, including attachments and approves secured third-party debt lenders provide unsecured credit to
other supporting materials, will become facilities because the collateral for such SBICs in an amount above $10 million?
part of the public record and subject to debt consists of the same assets SBA (c) What are the typical maturity dates
public disclosure. Sensitive information relies on to protect its creditor position. for such credit facilities (e.g., 12 month
and information that you consider to be SBA approval is not required for term) and are they routinely extended?

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38500 Federal Register / Vol. 80, No. 128 / Monday, July 6, 2015 / Notices

(d) What is the average balance and SBA has observed over the last few Authority: 15 U.S.C. 681.
settlement of credit lines extended to years that SBICs seeking to avoid
Javier Saade,
SBICs? Capital Impairment have converted non-
(e) Based on SBA’s view that short- ECI investments to ECI solely for the Associate Administrator for Investment and
term borrowings pose a lower credit Innovation.
purpose of attaining an increase in
risk, what restrictions, if any, should [FR Doc. 2015–16430 Filed 7–2–15; 8:45 am]
maximum allowable CIP. For example,
SBA consider placing on the length of an SBIC can convert a loan into equity, BILLING CODE 8025–01–P
time a balance may remain outstanding which would cause the investment to
on an unsecured line? then qualify as ECI. Depending on the
(f) Should SBA permit such facilities circumstances of the SBIC, the SMALL BUSINESS ADMINISTRATION
only during time periods of an SBIC’s converted security could cause the
lifecycle when the risk to SBA is lower, SBIC’s maximum allowable CIP to [Disaster Declaration #14334 and #14335]
for example during the early years of the increase and artificially forestall the
SBIC’s life or before additional leverage SBIC from having a condition of Capital Texas Disaster Number TX–00447
is drawn? If so, what considerations Impairment, which creates risk to
should SBA take into account in taxpayers. AGENCY:U.S. Small Business
determining the timing and duration of SBA has also observed the Administration.
these periods? deteriorating performance of portfolio
(g) Are there certain provisions in ACTION: Amendment 4.
companies held in a particular SBIC can
unsecured loan agreements that SBA likewise result in an SBIC’s maximum
should be especially concerned about SUMMARY: This is an amendment of the
allowable CIP increasing. Using the Presidential declaration of a major
with respect to credit risk (e.g., remedies
example in the prior paragraph, the loan disaster for the State of Texas (FEMA–
available to a lender such as specific
could have been converted to equity as 4223–DR), dated 05/29/2015.
performance or injunctive relief) and
a result of a distressed restructuring of
how should SBA deal with those Incident: Severe Storms, Tornadoes,
the company. In either case, the
provisions? Straight-Line Winds and Flooding.
(h) What type of credit risk policies increased ECI was not the result of the
would be most effective in managing SBIC making an ECI investment from Incident Period: 05/04/2015 through
SBA’s credit risk with respect to the outset, but instead converting non- 06/19/2015.
unsecured lines of credit? ECI based on the impairment status of Effective Date: 06/24/2015.
2. Determination of Equity Capital the SBIC or the deteriorated status of a
small concern. Physical Loan Application Deadline
Investments (ECI) in the calculation of Date: 07/28/2015.
an SBIC’s maximum allowable Capital SBA aims to prevent conversions
Impairment Percentage (CIP). 13 CFR specifically and solely intended to EIDL Loan Application Deadline Date:
107.1830(c) defines the maximum artificially increase maximum allowable 02/29/2016.
allowable CIP for a leveraged SBIC that CIP, because such conversions result in ADDRESSES: Submit completed loan
is not an Early Stage SBIC. If an SBIC the SBIC having a reduced collateral applications to: U.S. Small Business
exceeds its maximum allowable CIP, it position in the portfolio company at a Administration Processing and
constitutes a condition of Capital time when that collateral may be critical Disbursement Center, 14925 Kingsport
Impairment, which is an event of for SBA to obtain a recovery from the Road, Fort Worth, TX 76155.
default under the terms of its leverage. SBIC. However, in considering any
13 CFR 107.1810(f)(5). An SBIC’s policy changes to managing its credit FOR FURTHER INFORMATION CONTACT:
maximum allowable CIP depends on risk with respect to ECI, SBA does not Alan Escobar, Office of Disaster
two variables: (1) the percentage at cost seek to create unnecessary burdens for Assistance, U.S. Small Business
of ECI in the SBIC’s portfolio, and (2) SBICs who may convert an investment Administration, 409 3rd Street SW.,
the ratio of outstanding leverage to to ECI for business reasons unrelated to Suite 6050, Washington, DC 20416.
Leverageable Capital. solely avoiding Capital Impairment (e.g., SUPPLEMENTARY INFORMATION: The notice
Under 13 CFR 107.50, ECI generally the exercise of conversion rights prior to of the Presidential disaster declaration
means investments in a small business a planned IPO). Accordingly, the for the State of TEXAS, dated 05/29/
in the form of common or preferred Agency welcomes comments from the 2015 is hereby amended to include the
stock, limited partnership interests, public on how to achieve this objective. following areas as adversely affected by
options, warrants, or similar equity Comments may be general in nature the disaster:
instruments, including subordinated and/or answer the following questions:
debt with equity features if such debt (a) Other than the examples provided Primary Counties: (Physical Damage
provides only for interest payments in this notice, what transactions or and Economic Injury Loans): Fayette.
contingent upon and limited to the circumstances can result in an original Contiguous Counties: (Economic Injury
extent of earnings. Further, Leverageable non-ECI becoming qualified as an ECI? Loans Only):
Capital means, as more fully described (b) What specific factors should SBA Texas; Colorado; Lavaca; Washington.
in 13 CFR 107.50, paid-in capital of an consider in determining that
SBIC. investments are disqualified as ECI for All other information in the original
SBA’s regulations permit a higher the purposes of calculating an SBIC’s declaration remains unchanged.
maximum allowable CIP when the maximum allowable CIP? (Catalog of Federal Domestic Assistance
Lhorne on DSK7TPTVN1PROD with NOTICES

percentage of ECI in an SBIC’s portfolio (c) Without creating an undue Numbers 59002 and 59008)
is higher in recognition that equity-type reporting burden on SBICs, how can
investment strategies are inherently SBA differentiate between investments James E. Rivera,
riskier and frequently require a longer converted for legitimate business Associate Administrator for Disaster
holding period relative to debt reasons and those converted for other Assistance.
investments before a successful exit can reasons, including solely to inflate total [FR Doc. 2015–16429 Filed 7–2–15; 8:45 am]
be achieved. ECI in the SBIC’s portfolio? BILLING CODE 8025–01–P

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Document Created: 2015-12-15 13:17:23
Document Modified: 2015-12-15 13:17:23

Category		Regulatory Information
Collection		Federal Register
sudoc Class		AE 2.7: GS 4.107: AE 2.106:
Publisher		Office of the Federal Register, National Archives and Records Administration
Section		Notices
Action		Notice and request for comments.
Dates		Comments must be received on or before September 4, 2015.
Contact		Lyn Womack, Office of Investment and Innovation, 409 Third St. SW., Washington, DC 20416, (202) 205-2416.
FR Citation		80 FR 38499