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Panoptic Enterprises' FEDERAL CONTRACTS DISPATCH

DATE: December 6, 2002

SUBJECT: Small Business Administration; Certified Development Company (CDC) Loan Program

SOURCE: Federal Register, December 6, 2002, Vol. 67, No. 235, page 72622

AGENCIES: Small Business Administration (SBA)

ACTION: Advance Notice of Proposed Rulemaking (ANPR)

SYNOPSIS: SBA is considering ways to improve coverage of the CDC Loan Program (also known as the "504 Program") to make sure that all small businesses have access to long-term fixed-rate financing. After a review of public comments on the 504 Program, SBA will consider proposing amendments to existing program regulations that will improve overall program management, and may propose new legislation. SBA is reviewing the 504 Program policies in light of major changes in the economy, the financial services industry, technology, and in CDCs' operations since the program's inception in 1980.

EDITOR'S NOTE: The regulations governing CDCs are in Title 13 of the Code of Federal Regulations (CFR), Business and Credit Administration; Chapter 1, Small Business Administration; Part 120, Business Loans; Subpart H, Development Company Program (504), Sections 120.800 through 120.991.

DATES: Comments must be received no later than February 4, 2003.

ADDRESSES: Comments should be sent to James E. Rivera, Associate Administrator for Financial Assistance, U.S. Small Business Administration, 409 Third Street, SW, 8th Floor, Washington, DC 20416, or by e-mail to ANPR@sba.gov.

FOR FURTHER INFORMATION CONTACT: Gail H. Hepler, Chief, 504 Loan Policy Branch, U.S. Small Business Administration, 409 Third Street, SW, 8th Floor, Washington, DC 20416, 202-205-7630, or by e-mail to gail.hepler@sba.gov.

SUPPLEMENTAL INFORMATION: During the late 1970s and early 1980s, the prime interest rate and unemployment reached historically high levels. Long-term, fixed-rate money was not available at a reasonable cost to small businesses because of these high prevailing rates, and this was hindering job creation. Therefore, Congress enacted Section 504 of the Small Business Investment Act in 1980. The 504 Program was intended to provide fixed-rate financing for small businesses at favorable terms unavailable in the marketplace. The statute authorizes SBA to guarantee debentures backing long-term, fixed-asset loans (504 Loans) issued by CDCs. It also authorizes SBA to pool the guarantees and sell interests in the pools to investors.

Since enactment of the 504 program, the CDC industry has been developed to meet the job creation and economic development goals of the program. Several hundred CDCs either were started in local communities or amended their existing operations to participate in the program. There are currently approximately 270 CDCs. Each CDC has a specific geographic area of operations. In general, CDCs have a membership comprised of financial institutions, community organizations, businesses, and government organizations responsible for economic development in the CDC's area of operations. Some are independent entities devoted primarily to making 504 loans, and others are part of local or state governments. Almost 5,500 504 loans valued at approximately $2.47 billion were approved in FY 2002, and over the life of the program, more than $15 billion has been funded. Combined with the required private sector financing, this represents $42 billion in funding for growing small businesses. Overall, more than 39,000 loans have been approved resulting in the creation or retention of over 1,000,000 jobs since 1980.

However, since the CDC program was initially authorized, both the CDC industry and the economic environment in which it operates have changed significantly. Therefore, it is important that the SBA and those interested in the 504 Program work together to reexamine existing program policies and to consider new or revised policies to assure the program's continuing vitality and compliance with its statutory purpose, to foster economic development and create or preserve jobs. To that end, SBA is inviting public comments on the following questions as well as any other topic related to the 504 program. Comments may be addressed to one, all, or any combination of the following questions. Questions are grouped under the following headings for ease of review by the public.

Questions About Overall 504 Program Effectiveness

  1. Does the problem which the 504 Program was created to remedy, lack of small business access to long-term fixed-rate capital, still exist? What evidence exists to demonstrate this need?
  2. Is the 504 Program optimally designed to address the problem?
  3. Is the 504 Program designed to make a unique contribution in addressing the problem (that is, not needlessly redundant of any other federal, state, local or private effort)? Are there financial products in the private market that can remedy this problem?
  4. Does the 504 Program collaborate and coordinate effectively with related programs that share a similar purpose?
  5. How would the 504 Program demonstrate adequate progress in meeting the statutory goals of the program?
  6. What long-term performance goals would be appropriate for the 504 Program? Performance goals should be specific, ambitious, focused on outcomes, and meaningfully reflect the purpose of the program. In other words, how can SBA demonstrate the scale of the problem and show that the 504 Program is working to remedy the problem?
  7. What kind of evaluation would be most beneficial in measuring program effectiveness, both over the short term and the long term? Does the program currently gather the information necessary to make this evaluation?
  8. Does the performance of this program compare favorably to other programs with similar purposes, if any, and goals?

Questions to Current and Potential Small Business Borrowers

  1. Because 64% of all counties nationally did not receive any 504 funding averaged over a 2-year period, are the CDCs meeting all of the public demand for capital in both rural and urban areas?
  2. Would "special programs" in rural areas attract the needed capital that does not currently exist in the market today?
  3. Is the process for receiving a 504 Loan reasonable compared to other business lending? Substantive comments/recommendations are encouraged to provide the broadest benefit to SBA.
  4. Does the cost, time and requirements of receiving a 504 loan make the program unattractive compared to the 7(a) program?
  5. Is the 504 Program fulfilling its mission to bring fixed-rate financing to small business? If not, what steps can be taken to further the mission of the program?
  6. Many of the stated uses for 504 funding are similar to requests for funding for 7(a) loans. Are the programs redundant, are there additional changes that are required to the 504 Program to fill the lending gap to small business borrowers?

CDC Organizational Structure

  1. Should the CDC membership requirements be changed? If so, how should they be changed and still meet the test that the membership represents the economic development interests of the CDC's area of operations? For example, should a CDC be permitted to only have financial institutions as members? Should there be fewer members than 25?
  2. Should SBA permit for-profit CDCs again? If so,why? If not, why not? Should the existing, for-profit CDCs be required to become non-profit CDCs and thus meet the regulations governing all other CDCs? If so, by what period of time?
  3. Should SBA establish requirements to assure that a CDC remains viable? For example, should SBA establish a minimum cash reserve requirement? If so, at what level?
  4. What modifications to the regulations governing Premier Certified Lenders Program (PCLP) CDCs should be considered to increase participation by a larger number of CDCs?

Increasing Geographic Coverage by the 504 Program

  1. If a CDC has an existing area of operations in which it is not meeting the "adequately served" benchmark of one 504 loan per 100,000 population per year averaged over a two-year period, should it be permitted to expand its area of operations? Should it be required to shrink its area of operations?
  2. Should this same CDC have to shrink its area of operations by those counties in which it has not made a 504 loan? If so, when? What would be the period of time that would be reviewed?
  3. Even if a county is "adequately served," should a new CDC or an existing CDC be permitted to apply to include that county in its area of operations if there is only one CDC currently including that county in its area of operations?
  4. Depending on when a statewide CDC was approved and depending on whether other CDCs have been decertified or have been converted to Associate Development Companies, a statewide CDC may or may not include the entire state in its area of operations. Should all statewide CDCs be permitted to include the entire state in their area of operations?
  5. Should the definition of "adequately served" change to something other than one 504 loan per 100,000 population per year averaged over a two-year period? If so, what would be a better benchmark?
  6. When the Section 504 Development Company Loan Program was authorized in 1980, its purpose was to provide financing through corporations "formed by local citizens whose primary purpose is to improve their community's economy. They assist in the planned economic growth of the community by promoting and assisting the development of small business concerns in their area." Should SBA eliminate the requirement that a CDC have a specific area of operations? If so, how would the purpose of economic development be defined and monitored for each CDC?
  7. Would permitting applications for a multi-state CDC where the state is not contiguous to the CDC's state of incorporation provide greater access and a wider range of choices for borrowers?
  8. Should CDCs be required to adequately serve certain areas (for example, rural areas, enterprise zones) as a prerequisite to serving other areas? If so, what would be the requirement for "adequately served" in this case?
  9. Should SBA relax its standard of two CDC loan approvals per year for those CDCs that operate in a rural area?
  10. How can SBA best assure that small businesses in rural areas, where lack of population density makes lending more difficult and more expensive, have appropriate access to the 504 Program?
  11. Should SBA promulgate regulations that recognize that operational difference between CDCs that, because of local government affiliation or support, are limited to serving specified areas, and those CDCs that do not have such constraints.

504 Loan and Debenture Structure

  1. Presently only 10 and 20-year fixed-rate debentures are offered. Would 504 Program economic development objectives be better served if SBA made changes to the terms of debentures offered?
  2. What would the costs and benefits to borrowers, CDCs, private sector lenders, and any other party be if SBA provided a debenture product that amortizes monthly rather than semi-annually?
  3. Are there benefits to allowing CDCs to jointly participate in a 504 Loan project?
  4. Would a stand-alone debenture (no third-party lender requirement) for projects located in rural counties make 504 financing more attractive in these under-represented counties? If so, should there be a dollar limit on the project?

Performance Requirements

  1. SBA has developed a system that enables SBA and the CDC to track a CDC's 504 Loan portfolio performance as measured against SBA-established benchmarks as well as the CDC's peer group. To insure the quality of the 504 Loan portfolio as well as the accessibility of the program that could be severely jeopardized if defaults increase and/or recoveries decrease, resulting in an increase in future borrowers' fees to maintain the program at its zero subsidy, should SBA establish 504 loan portfolio performance requirements by CDC as a regulation? If so, since CDCs with large portfolios have a proportionately greater effect on the overall portfolio performance, but CDCs' with small portfolios are disproportionately affected by the failure of one loan, should there be a minimum portfolio size under which the regulation takes affect? If so, what should the size be?
  2. Should SBA require CDCs to have a financial stake in the performance of all of their 504 Loans, not just in the performance of any loan processed under PCLP authority? If so, what should be the requirement?

Operational/Logistical Issues

  1. What regulatory impediments are there to processing or closing 504 Loans?
  2. If a 7(a) lender closes and disburses a loan that SBA subsequently determines to be ineligible, SBA can deny liability under its regulations. If a CDC closes and disburses a 504 Loan that SBA subsequently determines to be ineligible, what financial or other penalty should be imposed on the CDC?

Definition of Economic Development

  1. Current regulations require a CDC to provide evidence to SBA that it has created at least one job per $35,000 of 504 debentures that it has issued. At the two-year anniversary of the small business's receipt of the loan proceeds, the CDC is required to document how many jobs were actually created. Should SBA require CDCs to provide evidence of other economic development in their Areas of Operations in addition to creating jobs? If so, what other evidence of economic development should be required, and what quantitative measures should be used?
  2. Should SBA develop a list of acceptable "economic development activities" in which SBA permits a CDC to invest its resources? If yes, what activities should be included? What activities should be excluded?

Participation in Other Programs

  1. Should SBA permit a CDC to contribute to the financial support of a 7(a) lender? Is this economic development as intended by Congress when it created the development company loan program?
  2. Should SBA permit a CDC to establish an affiliate relationship with a 7(a) lender through a management contract? Are there any benefits or drawbacks for borrowers?
  3. Should SBA permit a CDC to establish or acquire a 7(a) lender subsidiary? Is this economic development as intended by Congress? What are the benefits and drawbacks for borrowers?
  4. SBA's regulations prohibit a financial institution, among others, from controlling a CDC. Should SBA permit a 7(a) lender to establish a CDC affiliate or subsidiary controlled by the 7(a) lender?
  5. Should SBA permit a CDC to financially contribute to an SBIC? If so, under what limitations?
  6. Should SBA permit a CDC to establish an affiliate relationship with an SBIC through a management contract?
  7. Should SBA permit a CDC to establish an SBIC subsidiary? If so, under what limitations?
  8. Should SBA permit a separate corporation to have control through common management of the corporation, a CDC, and other corporations such as a 7(a) lender, an SBIC and so on? If so, under what limitations?

FOR FURTHER INFORMATION CONTACT: Panoptic Enterprises at 703-451-5953 or by e-mail to Panoptic@FedGovContracts.com.

Copyright 2002 by Panoptic Enterprises. All Rights Reserved.

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