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Report to Congressional Requesters:

October 2003:

COMMUNITY AND ECONOMIC DEVELOPMENT LOANS:

Securitization Faces Significant Barriers:

GAO-04-21:

GAO Highlights:

Highlights of GAO-04-21, a report to congressional requesters 

Why GAO Did This Study:

Community economic development (CED) lenders serve the credit needs of 
nonconventional borrowers and economically distressed areas across the 
nation. However, little is known about this industry, its ability to 
tap private sources of capital, and loan performance and volume in the 
industry. To provide information that would be helpful in considering 
the role that the federal government might play in facilitating the 
creation of a secondary market for CED loans, GAO was asked among 
other items to (1) determine the barriers to more widely securitizing 
CED loans and (2) identify options for overcoming these barriers and 
the likely implications of these options.

What GAO Found:

CED lenders rely on multiple federal programs that offer grants, 
loans, guarantees, and other support to help fund lending activities. 
Some of these lenders have expressed an interest in finding 
alternative sources of funding, including securitizing the loans that 
they make. However, the volume of CED loans potentially available for 
securitization is not known. In addition, the community economic 
development industry is characterized by nonstandard underwriting, 
loan documentation and loan performance information, and limited 
mechanisms for securitizing loans. Without greater understanding of 
available loan volume, the capital markets have little interest in 
developing standards or mechanisms for securitizing CED loans.

CED lenders also face barriers to securitizing their loans. Some of 
these barriers are unique to CED lending, including: limited lender 
capacity to manage a securitized portfolio of loans; the external 
legal and regulatory limitations and requirements governing the use of 
the funds that these lenders receive; and the high cost of originating 
and servicing CED loans.

This report describes options that the federal government might 
exercise to address the identified barriers. This report also 
describes the implications that implementing each option might have, 
including the potential for increased federal costs and changes in 
lenders’ missions. Ultimately, securitization may not be a significant 
alternative for CED lenders until the volume of loans available for 
securitization is better known and lenders are convinced of the 
benefits of participating.


www.gao.gov/cgi-bin/getrpt?GAO-04-21.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact William Shear at 
(202) 512-4325 or shearw@gao.gov.

[End of section]

Contents:

Letter: 

Results in Brief: 

Background: 

CED Lenders Share Similar Missions, but Markets Targeted and Loan 
Information Vary: 

As with the Lenders They Serve, Federal Programs Share Similar 
Missions, but Differ in How They Operate: 

Selected Securitization Models for Small Business and CED Loans Have 
Similarities and Differences: 

We Identified Barriers to Securitizing CED Loans: 

Potential Options Exist to Overcome Barriers, but Most Imply Costs or 
Changes to Federal Programs: 

Observations: 

Agency Comments and Our Evaluation: 

Appendixes:

Appendix I: Objectives, Scope, and Methodology: 

CED Lender Characteristics and the Performance of their Loans: 

Selected Federal CED Programs: 

Selected Securitization Efforts for CED Loans: 

Barriers to CED Loan Securitization: 

Options for Securitization and Their Implications: 

Appendix II: Model Descriptions: 

Tables: 

Table 1: Sources of Lender Funding: 

Table 2: Federal Programs and Type of Assistance Provided to CED 
Lenders:

Table 3: Summary of Programs and Their Target Market Criteria: 

Table 4: Appropriations for CED Lending Have Declined in Selected 
Federal Programs (Fiscal Years 1998-2003): 

Table 5: Number of Lenders and Dollar Volume of Federal Support (Fiscal 
Years 1998-2002) A: 

Table 6:  Securitization Models and Lenders and Borrowers Involved: 

Table 7:  Types of Loans Pooled Varies by Model: 

Table 8:  Credit Enhancements Used to Distribute Credit Risks Vary by 
Model: 

Table 9: Federal CED Lending Programs, Lender Types, and Sponsoring 
Agencies Included in Our Review: 

Figures: 

Figure 1: Role of Participants in a Common Securitization Model: 

Figure 2: Business and CED Loan Performance Measures Collected about 
Each Lender Type: 

Figure 3: Levels of Outstanding Securitized Loans Have Not Reached the 
Levels of More Well-Established Models: 

Abbreviations: 

ARC: Appalachian Regional Commission:

BRV: bankruptcy-remote vehicle:

CED: Community and Economic Development:

CDA: Commonwealth Development Associates: 

CDBG: Community Development Block Grant:

CDC: Community Development Corporation:

CDFI: Community Development Financial Institution:

Commerce: U.S. Department of Commerce:

CRF: Community Reinvestment Fund:

CSBG: Community Services Block Grant:

EC/EZ: Enterprise Community/Empowerment Zone grant:

EDA: Economic Development Administration:

EDI: Economic Development Initiative:

HUD: U. S. Department of Housing and Urban Development:

HHS: U. S. Department of Health and Human Services:

IRP: Intermediary Relender or Intermediary Relending Program:

RBEG: Rural Business Enterprise Grant:

RLF: Revolving Loan Fund:

SBA: U.S. Small Business Administration:

SEC: U.S. Securities and Exchange Commission:

Treasury: U.S. Department of the Treasury:

USDA: U.S. Department of Agriculture:

504 CDC: Section 504 Certified Development Companies:

Letter 
October 17, 2003:

Congressional Requesters:

Community and economic development (CED) lenders make loans to 
qualified businesses that are generally unable to obtain suitable 
financing from conventional private-sector lenders. CED lenders rely on 
a variety of funding sources including the federal government, but tend 
not to rely on securitization as a funding source.[Footnote 1] If 
properly structured, securitization represents an option that could 
offer lenders increased liquidity for additional lending and offer 
borrowers greater availability of loanable funds.[Footnote 2] Some of 
the federal programs that support CED lending have considered using 
securitization to provide lenders greater access to capital.

This report responds to your July 11, 2002, request for information on 
CED lending. Based on the potential benefits that securitization may 
offer lenders and borrowers, you asked us to describe the 
characteristics of (1) selected federally sponsored CED lenders, (2) 
the federal programs that sponsor them, and (3) selected existing and 
proposed models for securitizing CED loans. You also asked that we (4) 
determine the barriers to more widely securitizing CED loans, and (5) 
identify options for overcoming these barriers and the implications of 
these options.

To address the first two objectives, we reviewed studies and other 
documents obtained from lender trade associations, program regulations, 
procedures, and guidance and spoke with program and industry officials 
representing seven federally sponsored CED lenders we were requested to 
review and the federal programs that support them.[Footnote 3] To 
describe efforts to securitize CED loans, we reviewed agency and trade 
association documents and spoke with representatives of organizations 
undertaking securitization efforts. To determine the barriers to 
securitizing CED loans and potential options for overcoming them, we 
synthesized information from our literature search, as well as 
information gathered from interviews with program officials, CED lender 
representatives, capital market participants, researchers, and others 
knowledgeable about CED lending and securitization. Finally, we 
developed additional options the federal government might exercise for 
potentially overcoming identified barriers and explored the 
implications of these options, as well as those proposed by others. The 
options for overcoming the barriers often entail additional federal 
costs and, given the scope of this review, we were unable to determine 
whether the benefits would exceed the costs that could result from such 
efforts. Therefore, we do not endorse these options. Also, our work 
focused on access to capital through securitization, not through other 
means. We conducted our work in Washington, D.C; Philadelphia, 
Pennsylvania; and Manchester, New Hampshire, between October 2002 and 
July 2003 in accordance with generally accepted government auditing 
standards.

Results in Brief:

While the seven groups of CED lenders we reviewed have similar 
missions, available data show variation in the types of borrowers they 
serve, the investments they make, and how they are 
capitalized.[Footnote 4] However, little is known about the industry as 
a whole. CED lenders vary in the types of loans they make. For example, 
some lenders tend to focus on operating loans, while others may focus 
on real estate loans. Lenders are funded by federal, as well as state, 
local, private, and philanthropic funding sources. Federal funding 
sources, however, are important for all of the lenders included in our 
review because they provide lenders engaged in high-risk lending with 
low-cost funding. Data on the amounts the lenders invest in communities 
were not current or complete for lenders in our review. In addition, 
because data on lender activity are reported through multiple channels, 
data on the total number of lenders and the amount they invest--as a 
group--in communities are not available. Loan performance data were not 
available or current on all lenders. Finally, because of the various 
sources of data on CED lenders, loan performance is not consistently 
defined. Therefore, it is difficult to describe the performance of CED 
loans.

The federal programs that support CED lenders have similar missions--to 
improve economic conditions in communities considered to be distressed 
or underserved. However, the type of federal support they provide and 
the targeted lending criteria they use differ. These programs also 
differ in terms of the number and type of lenders they support and 
awards made. In fiscal years 1998--2002 these federal programs provided 
billions to support CED lending in the form of grants, loans, loan 
guarantees, and equity investments. However, federal funding for some 
of these programs has declined in recent years. Some programs use 
securitization, or have considered using securitization, to help 
lenders in accessing capital markets to maintain or expand lending 
activity. Finally, these programs collect and maintain data to oversee 
lender's activities using various methods and have different reporting 
requirements.

The five existing and three proposed securitization models that we 
reviewed illustrate a variety of structures to securitize small 
business and CED loans and vary in the amount of CED loans that they 
securitize.[Footnote 5] Each of the existing and proposed models varies 
in terms of the types of loans pooled and the method for pooling the 
loans. All of the models we reviewed utilize or propose differing forms 
of credit enhancements, funded by the federal government, participating 
lenders, or others to limit credit risk to investors.[Footnote 6] 
Accordingly, each of the models distributes the risks and benefits 
associated with securitization differently among participants--
borrowers, lenders, poolers, investors, and government(s). The 
structure of these models can affect participants' willingness to 
engage in securitization and cost incurred by the federal government.

We identified six key barriers to securitization, all of which keep 
lenders from working with capital markets.

* First, borrower demand is not known across targeted markets, and CED 
lenders generally lack incentives--both market-based and federally 
driven--to participate in securitization. As a result, the volume of 
loans that could be securitized is not well understood.

* Second, many CED lenders lack the capacity to securitize their loans. 
For instance, their reliance on small, less-diversified portfolios that 
require intensive servicing results in higher per loan costs. Also many 
lenders do not have financial information--such as their cost to 
originate and service these loans and the expected income from these 
loans--that is needed to assess whether securitization is a viable 
option. Nor can they readily obtain the staffing resources or skills 
needed to expand lending activity that might be required when 
securitizing their loans.

* Third, external requirements--statutory or programmatic--attached to 
funding sources may directly or indirectly inhibit the securitization 
of loans.

* Fourth, CED lenders believe that selling their below-market-rate 
loans would require them to absorb too high a discount to benefit from 
a securitization.

* Fifth, lack of lender standardization and performance information 
impedes securitization by increasing the cost of securitizing these 
loans.

* Finally, mechanisms available to support securitization for CED 
loans, such as information links between capital markets and lenders 
and loan pool assemblers, are limited in number and capacity.

We identified a range of options the federal government could use to 
address each of the barriers to securitization. Undertaking any of 
these options could have important implications in terms of cost to the 
federal government, mission of CED lenders, and lender and program 
management. For instance, to address lack of lender participation, 
incentives could be built into existing federal programs for lenders 
who are willing and capable of securitizing their loans. However, such 
incentives might require federal funds, and the extent to which this 
might result in sufficient loan volume to make securitization viable is 
not clear. To improve lender capacity, the government could allow for 
set-asides within existing programs for training and technical 
assistance to lenders designed to help lenders improve portfolio 
management, staff skills, and their financial information. This option, 
however, might reduce the funds available to support lending. The 
government could also remove program restrictions that inhibit or 
prohibit securitization such as restrictions on the use of loan 
repayments, which could affect lender missions. To improve 
standardization and performance information, the government could 
provide incentives for lenders and capital market participants to 
develop a useful level of standardization and performance information 
tailored to CED loans--which could lower the cost of underwriting 
loans, but could also result in lenders moving away from target 
markets. Such incentives could include funding set-asides, changes in 
program award selection criteria, or even increased program funding to 
those lenders--all of which may entail added program costs that should 
be assessed. Improved information on lending activity and loan 
performance could also help managers make better program decisions. To 
overcome the limited mechanisms to securitize CED loans, the federal 
government could provide a variety of different credit enhancements 
that would improve the investment quality of these securities and 
minimize standardization requirements for lenders, but which might also 
have a negative financial impact on the federal budget.

While we do describe the likely implications of many of the options we 
identified, we did not measure the extent to which each may affect 
lenders' mission, federal costs, program oversight, and other potential 
implications. Likewise, we did not determine whether the benefits would 
exceed the costs that could result from such efforts. We, therefore, 
did not endorse these options, and this report contains no 
recommendations. The information we present provides a framework for 
understanding the challenges, benefits, and costs of securitization. 
Based on our findings and this framework, the final section in this 
letter presents some observations on the nature of barriers CED lenders 
face in securitizing loans.

We provided a draft of this report to the U.S. Department of 
Agriculture (USDA); U.S. Department of Commerce (Commerce); U.S. 
Department of Housing and Urban Development (HUD); U.S. Department of 
Treasury (Treasury); U.S. Small Business Administration (SBA); U.S. 
Department of Health and Human Services (HHS); and the Appalachian 
Regional Commission (ARC). Officials in all agencies provided technical 
comments that we incorporated into the report, where appropriate. The 
technical comments from HHS were from officials in HHS's Administration 
for Children and Families. Generally the agencies did not indicate 
whether they agreed or disagreed with the report's findings.

Background:

The federal government funds CED lending through a variety of 
mechanisms, including grants, loans, loan guarantees, and tax 
expenditures. Many government officials, academics, CED lenders, and 
nonprofits have recognized the value of identifying ways to maximize 
the impact of CED dollars. These efforts have resulted in alternative 
mechanisms CED lenders can use to access private, rather than 
governmental, funding for CED purposes. For example, CED lenders have 
worked with local banks by providing subordinate financing.[Footnote 7] 
Lenders have also received equity-like investments from banks. In 
addition, lenders have sold CED loans to replenish loan funds. Many 
have studied securitization of CED loans as a potential option to 
access additional private capital.

Securitization is a process that packages relatively illiquid 
individual financial assets, such as loans, leases, or receivables with 
common features, and converts them into interest-bearing, asset-backed 
securities with characteristics marketable to capital market 
investors.[Footnote 8] As outlined in figure 1, the participants in 
securitization--borrowers, originating lenders, pool assemblers, 
credit raters, investors, and sometimes third-party credit enhancers--
each assume specific roles during the transaction. Additionally, each 
of these participants derives specific benefits from the transaction. 
For example, borrowers gain access to loanable funds with favorable 
terms--such as longer payment terms and fixed rates--that may otherwise 
be unavailable. Securitization offers originating lenders a tool to 
improve their risk and balance sheet management, as well as potential 
new fee or income streams and the ability to put existing capital to 
other purposes. Securitization also allows the cash flows from pools of 
assets to be structured to match the appetites of investors; thus, 
investors can diversify with access to new securities that satisfy 
their maturity, risk, and return preferences.

Figure 1: Role of Participants in a Common Securitization Model:

[See PDF for image]

[A] Also known as a special purpose vehicle, a bankruptcy-remote 
vehicle is established to legally purchase the financial assets for the 
purposes of removing the assets from the credit risk associated with 
asset originators or the pool assembler.

[End of figure]

The degree to which participants receive these benefits depends largely 
on how well, or efficiently, the markets for securitized assets are 
functioning. With better current and historical performance data on 
financial assets, capital markets can more easily profile the risk of a 
pool of similar assets. This risk can be divided and sold to investors 
who are willing to purchase it at an acceptable risk-adjusted return 
(investor-required yield). As the markets for particular securitized 
assets grow more voluminous and liquid, and the performance of 
securitized assets as well as the risks associated with securitization 
become better understood, investor-required yields on particular asset-
backed securities can decline. Additionally, the transaction costs of 
securitizing assets can also decline as the assets become better 
understood. Declining investor-required yields and transaction costs 
can lower the cost of financing for originating lenders and ultimately 
borrowers. Conversely, with inadequate performance data, and low 
volumes of similar financial assets, these benefits may not 
sufficiently materialize for securitization to be a viable financing 
arrangement for originating lenders and borrowers.

Home mortgages are the most well-established securitization market in 
the United States. Private conduits, such as commercial banks, and 
governmentally sponsored conduits such as the Federal National Mortgage 
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation 
(Freddie Mac), have combined to securitize trillions of dollars of home 
mortgages over the past three decades. According to the Federal 
Reserve, as of the end of 2002, there were over $3 trillion dollars of 
securitized home mortgages outstanding. With visible and voluminous 
demand for home mortgage financings evident in the late 1960s and early 
1970s, Congress restructured Fannie Mae and created Freddie Mac and the 
Government National Mortgage Association (Ginnie Mae) to provide 
secondary market outlets for home mortgage lenders using private 
capital.[Footnote 9] Ginnie Mae pioneered the securitization of the 
Federal Housing Administration and the Veteran's Administration home 
mortgages--which already had standard underwriting and documentation 
guidelines, robust secondary markets, and benefited from federal 
guarantees--in 1970. Freddie Mac, and later Fannie Mae, did the same 
for nonfederally guaranteed mortgages, developing uniform guidelines 
for mortgage underwriting and documentation, and educating a diverse 
set of mortgage lenders nationwide about the benefits of 
securitization.

In addition to home mortgages, financial assets such as commercial 
mortgages, consumer credit receivables, and even small business and CED 
loans have been securitized.[Footnote 10] Today, outstanding 
securitized commercial mortgage and consumer credit receivable volume 
ranges in the hundreds of billions of dollars. However, despite 
favorable regulatory treatment, lending institutions have securitized 
less than $6.2 billion of nonfederally guaranteed small business loans 
from 1994 through 2001.[Footnote 11] During this same time frame, 
lending institutions securitized approximately $22 billion of SBA-
guaranteed small business loans.[Footnote 12] As a rough point of 
comparison, in June 2001 commercial banks held an estimated $450 
billion in outstanding small business loans.[Footnote 13] In a previous 
report, we attributed the lack of securitized small business loans to 
the wide variety of small business loan products, difficulty 
communicating the performance of small business loans sufficiently and 
cost-effectively to capital markets, and sporadic visible financial 
benefits for originating lenders and investors to securitize these 
loans.[Footnote 14]

CED Lenders Share Similar Missions, but Markets Targeted and Loan 
Information Vary:

The seven types of federally sponsored CED lenders reviewed have 
similar missions: to service the credit needs of small businesses and 
others that generally cannot access funding otherwise or are located in 
communities that are considered underserved. However, these lenders 
differ in the types of borrowers they serve, the types of loans they 
make, and their sources of funding. Also, the total number of lenders 
and the amount they invest in communities are not known. Finally, the 
performance of CED loans is difficult to describe because consistent 
performance data are not available for all lenders in our review.

Lenders Have Similar Missions in Financing Underserved Markets:

All of the lenders we reviewed have similar missions to service CED 
credit needs in low-and moderate-income communities or borrowers that 
are considered to be underserved. Borrowers served by CED lenders are 
perceived by traditional sectors as high risks--that is, they have 
difficulty accessing credit either because they have poor or 
nonexistent credit histories, insufficient collateral, or are start-up 
businesses with no track record. Some lenders also help borrowers gain 
access to capital from conventional sources (for example, banks) by 
providing a portion of what the business needs and agreeing to let the 
bank recoup its losses first from the business' collateral in the event 
of default.

CED lenders employ several strategies to meet their missions. For 
instance, they work extensively with their borrowers and target loans 
rejected by banks. According to lenders with whom we talked and studies 
we reviewed, lenders must work extensively with their borrowers, 
providing loan servicing and technical assistance to help borrowers 
make consistent loan payments and sound business decisions to ensure 
their survival. In addition, lenders also devote more time to their 
borrowers than that required for conventional loans to help borrowers 
qualify for CED loans.

Lenders Target a Range of Borrowers and Products and Receive Funding 
from Various Sources:

While overall missions of CED lenders we reviewed are similar, they 
differ somewhat in terms of the types of borrowers they serve, products 
they offer, and the targeted location of their investments. The lenders 
may support a range of borrowers, from poverty-level to moderate-
income. Many of the lenders focus on start-up businesses. Some lenders 
have more specific targets. For example, microlenders serve businesses 
with five or fewer employees and capital of $25,000 or less. Lenders 
may offer loans for working capital, equipment, or real estate; 
however, some concentrate more on one type of loan than others. For 
example, 504 Certified Development Companies focus on commercial real 
estate and equipment loans, while microlenders concentrate on working 
capital and equipment loans. Some lenders service specific geographic 
areas. For instance, ARC Business Development Revolving Loan Fund 
lenders service borrowers in the Appalachian region.

As shown in table 1, lenders receive funding from various sources 
including federal, state, local, private, and philanthropic sources of 
capital as well as earned income. According to lenders, trade 
association representatives and studies we reviewed, federal funding 
sources are important because they provide low-cost capital for high-
risk loans they finance. In addition, federal funding makes up a 
significant portion of the capital available to some lenders. We also 
found that the source of federal funding for these lenders varies. For 
instance, federal funding for CDFIs comes from the U.S. Department of 
Treasury. In addition, some CDFIs--particularly those that finance 
microloans, and that are also classified as CDCs--also receive funding 
from HUD, SBA, Commerce, USDA, and HHS.

Finally, lenders generate income from interest earned and 
administrative fees they charge borrowers for services and loans. 
According to lenders and other research, lenders rely on these earned-
income sources to cover their operating costs. Earned income also is 
important to many lenders because other funding sources do not allow 
lenders to use a portion of the funding to cover operating costs.

Table 1: Sources of Lender Funding:

Community Development Financial Institutions (CDFI); Nonfederal 
sources: State: Yes; Nonfederal sources: Local: Yes; Nonfederal 
sources: Private: Yes; Nonfederal sources: Earned Income: Yes; 
Nonfederal sources: Other[A]: Yes; Federal sources: Treasury: Yes; 
Federal sources: Commerce: Yes; Federal sources: HUD: Yes; Federal 
sources: USDA: Yes; Federal sources: SBA: Yes; Federal sources: HHS: 
Yes; Federal sources: ARC: No.

Microlenders; Nonfederal sources: State: Yes; Nonfederal sources: 
Local: Yes; Nonfederal sources: Private: Yes; Nonfederal sources: 
Earned Income: Yes; Nonfederal sources: Other[A]: Yes; Federal 
sources: Treasury: Yes; Federal sources: Commerce: No; Federal 
sources: HUD: No; Federal sources: USDA: No; Federal sources: SBA: 
Yes; Federal sources: HHS: Yes; Federal sources: ARC: No.

Community Development Corporations (CDC); Nonfederal sources: State: 
Yes; Nonfederal sources: Local: Yes; Nonfederal sources: Private: Yes; 
Nonfederal sources: Earned Income: No; Nonfederal sources: 
Other[A]: Yes; Federal sources: Treasury: Yes; Federal sources: 
Commerce: Yes; Federal sources: HUD: Yes; Federal sources: USDA: Yes; 
Federal sources: SBA: Yes; Federal sources: HHS: Yes; Federal sources: 
ARC: No.

Revolving Loan Fund lenders (RLF)[B]; Nonfederal sources: State: Yes; 
Nonfederal sources: Local: Yes; Nonfederal sources: Private: Yes; 
Nonfederal sources: Earned Income: Yes; Nonfederal sources: Other[A]: 
Yes; Federal sources: Treasury: No; Federal sources: Commerce: 
Yes; Federal sources: HUD: Yes; Federal sources: USDA: Yes; Federal 
sources: SBA: Yes; Federal sources: HHS: Yes; Federal sources: ARC: 
Yes.

Intermediary Relenders (IRP); Nonfederal sources: State: Yes; 
Nonfederal sources: Local: Yes; Nonfederal sources: Private: Yes; 
Nonfederal sources: Earned Income: Yes; Nonfederal sources: Other[A]: 
No; 
Federal sources: Treasury: No; Federal sources: Commerce: No; 
Federal sources: HUD: No; Federal sources: USDA: Yes; Federal 
sources: SBA: No; Federal sources: HHS: No; Federal sources: 
ARC: No.

504 Certified Development Companies (504 CDC); Nonfederal sources: 
State: No; Nonfederal sources: Local: No; Nonfederal sources: 
Private: Yes; Nonfederal sources: Earned Income: Yes; Nonfederal 
sources: Other[A]: Yes; Federal sources: Treasury: No; Federal 
sources: Commerce: No; Federal sources: HUD: No; Federal 
sources: USDA: No; Federal sources: SBA: Yes; Federal sources: HHS: 
No; Federal sources: ARC: No.

Lenders supported by HUD's Section 108 and CDBG programs[C]; 
Nonfederal sources: State: No; Nonfederal sources: Local: No; 
Nonfederal sources: Private: No; Nonfederal sources: Earned Income: 
Yes; Nonfederal sources: Other[A]: No; Federal sources: 
Treasury: No; Federal sources: Commerce: No; Federal sources: 
HUD: Yes; Federal sources: USDA: No; Federal sources: SBA: No; 
Federal sources: HHS: No; Federal sources: ARC: No.

Sources: Lender trade associations and federal programs.

[A] Other includes individual investors, philanthropic investors, and 
utilities.

[B] Includes EDA-and ARC-sponsored RLFs. However, RLFs may receive 
funding from multiple federal sources.

[C] HUD Section 108 and CDBG lenders are local government agencies or 
nonprofit intermediaries.

[End of table]

Total Number of CED Loans and Amount of CED Lending Are Not Known:

Data on the number and amount of CED loans invested in communities are 
not current or complete for all lenders targeted by our review. For 
example, data on the number and amount of loans these lenders make are 
sometimes only collected for a sample of lenders. Data on the number 
and amount of loans for microlenders were collected in September 2000, 
but cover only 308 of the 554 identified microlenders. Similarly, the 
most recent reporting time frame for 504 CDC data is fiscal year 2001 
but covers about 272 lenders. Data on the amount and number of CDFI 
loans covers 389 of the 800--1000 CDFIs identified. The latest survey 
on Community Development Corporation lenders was completed in 1997 and 
indicated that there were an estimated 3,600 CDCs nationwide--as many 
as 776 reported making CED loans.[Footnote 15] Data on loan numbers and 
amounts for IRPs cover only 29 out of the 400 IRPs identified by the 
trade association that represents them. Data are reported on 422 
Department of Commerce RLFs and 1,012 lenders supported by Section 108 
and CDBG programs. However, the total universe of these lender types is 
unknown.[Footnote 16]

In addition, it is impossible to aggregate available data to determine 
the total number of CED lenders and the number or dollar volume of 
loans they make because some lenders may be counted in more than one 
lender group. For instance, as indicated previously, both microlenders 
and CDCs may also be CDFIs. Many lender types can be supported by HUD's 
Section 108 and CDBG grant programs. Given the data limitations, the 
total volume of loans and dollars invested in communities through CED 
lending is also unknown.

Loan Performance Data Are Limited, but Attempts Have Been Made to 
Improve Data:

Loan performance data, including data on loan delinquencies, defaults, 
and loss rates were not available, complete or defined consistently for 
both ongoing and one-time data collection efforts (see figure 
2).[Footnote 17] For example, loan performance data are not available 
for CDCs at all. The CDFI Fund and other ongoing sources of data on 
CDFIs do not track default rates at all. Conversely, ongoing data 
collection on IRPs covers defaults and delinquencies, but only at an 
aggregate level--not at a loan level. In fact, only EDA, SBA, and ARC 
collect loan-level performance information on an ongoing basis (for the 
RLF, 504 CDC, Microlenders, and ARC/RLF programs).

Figure 2: Business and CED Loan Performance Measures Collected about 
Each Lender Type:

[See PDF for image]

[A] Rutgers University, "EDA RLFs--Performance Evaluation," 2002. These 
data do not include non-EDA RLFs.

[B] Urban Institute, "Public-Sector Loans to Private-Sector Businesses: 
An Assessment of HUD-Supported Local Economic Development Lending 
Activities," 2003.

[C] While the total number of lenders is not known, loans covered by 
the 51 lenders in the Urban Institute Study account for over 50 percent 
of third-party lending for CED loans made, and up to 58 percent and at 
least 96 percent respectively, of third-party CED loan dollars tracked 
in HUD's CDBG and Section 108 state and local entitlement programs. 
Therefore, coverage is fairly high.

[D] Abt Associates, Inc., "CDFI Fund Secondary Market Survey of CDFIs," 
2002.

[E] Abt surveyed 108 CDFIs but received only 54 responses from the 
survey on loan-level performance data. In addition, all measurements 
were not reported on all loans. For instance, recovery amounts are 
available on fewer than 2 percent of the loans. Measurements for 
delinquencies reported 30 days past due are available on 44 percent of 
the loans included.

[F] Corporation for Enterprise Development, CDFI Data Project FY 2001.

[G] The latest CDFI Data Project survey indicates all respondents 
surveyed did not report on each data point requested. Therefore, these 
measures are available on only 389 of all 512 CDFIs surveyed. CFED also 
disclosed that they could not guarantee the reliability of the data.

[H] SBA quarterly reports for the 174 microlenders participating in 
SBA's microloan program; and Aspen Institute, " Directory of U.S. 
Microenterprise Programs," 2002, for the estimated number of 
microlenders, totaling 554.

[I] EDA program data as of May 2003.

[J] Data are collected but are maintained in hard copy at various 
regional offices and, therefore, not useable.

[K] ARC program data as of February 2003.

[L] National Association of Development Organizations Biennial Survey 
data as of March 2003.

[M] SBA 504 program data 2003.

[N] National Congress for Community and Economic Development 1999 
Census.

[End of figure]

EDA and HUD recently completed one-time studies on RLF lenders, lenders 
funded by Section 108 and CDBG, respectively, that included analysis of 
loan-level performance data (see figure 2). In addition, the CDFI fund 
has received and consolidated loan-level data as part of its ongoing 
Secondary Market Feasibility Study. We attempted to obtain summary data 
from these sources on the dollar amount and number of loans in default 
in order to estimate a cumulative default rate for each program. 
Although CDFI Fund does not collect default data, they recently began 
collecting loan-level data and tracked information on loan write-offs. 
We, therefore, attempted to obtain CDFI write-off data as a proxy for 
default measures. However, we found that loan-level data from the CDFI 
Fund lacked data on the timing of write-offs. This information was 
requested from the lenders in the study's survey; however, only 10 
percent of the reported loans included the date of write-off. Without 
knowing the timing of defaults, it is not possible to account for 
differences in default rates attributed to the age of a loan. According 
to data provided by Rutgers University, non-real estate, loans made by 
EDA/RLFs between 1988--1995 have, on a weighted average basis, a 4-year 
cumulative default rate of 4 percent.[Footnote 18] The ultimate default 
rate cannot be calculated until loans have had an opportunity to reach 
maturity. Comparable data on HUD loans were not available at the time 
of this report.

Where loan performance measures did exist in aggregate form, they were 
defined inconsistently across lenders. For instance, delinquencies for 
IRPs are defined as loans up to 90 days past the due date, whereas 
delinquencies are defined for CDFIs as failure to make a payment as 
early as 31 days and up to 90 days past the due date. Defaults for EDA 
RLFs are defined as 60 days past due, but not written off; whereas, the 
defaults for lenders supported by HUD's Section 108 and CDBG programs 
are defined as more than 90 days delinquent with no further payments 
expected.

As with the Lenders They Serve, Federal Programs Share Similar 
Missions, but Differ in How They Operate:

We reviewed 11 federal programs that fund the seven CED lenders 
included in our study. These programs are administered by EDA, 
Treasury, HUD, USDA, SBA, ARC, and HHS.[Footnote 19] The programs have 
a similar purpose in that each was established to improve economic 
conditions in communities considered distressed or underserved. 
However, the programs differed in how they achieved their purposes and 
the size and level of activity. Some programs in our review have 
experienced budget reductions. We also found that several programs have 
considered securitization as an option to increase access to capital. 
Finally, few programs regularly collect information on the performance 
of lenders and the loans they make. Consequently, little information is 
known about the dollar volume or number of loans that some of these 
federal programs have funded to support CED lending in communities 
across the country.

Federal Programs Have Similar Purpose but Different Requirements and 
Forms of Support:

The 11 programs we reviewed were established to improve economic 
conditions in distressed or underserved communities. However, the 
programs differed in the form of federal assistance offered to CED 
lenders, and the targeting of assistance to specific geographic areas, 
borrowers, or businesses.

As noted in table 2, 6 of the 11 programs in our review helped fund CED 
lending through grants only; one program used loans only; two used loan 
guarantees only; one used a combination of loans and loan guarantees; 
and another used a combination of grants, loans and equity investments. 
The programs provide lenders with funds that may be loaned to borrowers 
and the proceeds from repayments on the loans may be used to make 
additional loans for community and economic development.[Footnote 20] 
All but one of the programs allowed lenders to establish their own 
rates and terms.[Footnote 21] In general, programs required that 
lenders' applications include a discussion of how they planned to use 
the funds, which might include lenders' targeting criteria for 
borrowers, interest rates, and terms. Finally, all but the 504 CDC 
program receive some level of government subsidy.

Table 2: Federal Programs and Type of Assistance Provided to CED 
Lenders:

1; Federal program: Intermediary Relending Program (IRP); Loan: Yes; 
Grant: No; Loan guarantee: No.

2; Federal program: Rural Business Enterprise Grant (RBEG); Loan: 
No; Grant: Yes; Loan guarantee: No.

3; Federal program: Economic Adjustment Assistance Program (EDA RLF); 
Loan: No; Grant: Yes; Loan guarantee: No.

4; Federal program: Business Development Program Revolving Loan Fund 
(ARC RLF)[A]; Loan: No; Grant: Yes; Loan guarantee: No.

5; Federal program: Community Development Block Grant (CDBG); Loan: 
No; Grant: Yes; Loan guarantee: No.

6; Federal program: Section 108 loan guarantee; Loan: No; Grant: 
No; Loan guarantee: Yes.

7; Federal program: Community Services Block Grant (CSBG); Loan: 
No; Grant: Yes; Loan guarantee: No.

8; Federal program: Empowerment Zone/Enterprise Community Grant (EZ/
EC); Loan: No; Grant: Yes; Loan guarantee: No.

9; Federal program: Financial Assistance component of CDFI Fund[B]; 
Loan: Yes; Grant: Yes; Loan guarantee: No.

10; Federal program: 504 Certified Development Company (504 CDC); Loan: 
No; Grant: No; Loan guarantee: Yes.

11; Federal program: Microloan Direct and Loan Guarantee programs; 
Loan: Yes; Grant: No; Loan guarantee: Yes.

Source: Federal program documents.

[A] ARC is authorized to make loan guarantees but has not used this 
authority in the last 13 years.

[B] Also offers equity investments, deposits, and credit union shares.

[End of table]

* The seven grant programs we reviewed permit grantees to use funds for 
operating RLFs, as well as for other economic development activity--for 
example, acquisition or development of land, or provision of public 
water and sewer facilities.[Footnote 22]

* Two loan programs--USDA's IRP, and SBA's Microloan program--offer 
lenders loans with low rates and relatively long repayment terms. For 
example, IRPs receive loans at 1 percent interest to be repaid within 
30 years. The low cost of the federal loan could enable the lender to 
pass on low loan payments to borrowers. SBA's Microloan program makes 
loans to lenders that lenders then use to make microloans to eligible 
borrowers. Lenders may receive loans of up to $750,000 to be repaid 
within 10 years. Each lender is limited to a maximum of $3.5 million 
outstanding at any one time. SBA looks to the lending intermediary to 
pay its loans in full, regardless of the payment history of individual 
borrowers. Borrowers, unable to obtain credit from a traditional 
lending institution, also benefit from the technical assistance to 
improve their business' chance of success.[Footnote 23]

* The three loan guarantee programs--HUD's Section 108 and SBA's 504 
Certified Development Company (504 CDC) and Microloan programs--offset 
all or a part of the credit risk of loans by providing participating 
lenders with a loan guarantee on all or part of the loan payments in 
the event of a borrower default. In the Section 108 program, the 
principal security for the loan guarantee is a pledge by the applicant 
community or the state (for nonentitlement communities) of its current 
and future CDBG funds. Under the 504 CDC program, SBA guarantees loans 
made by 504 CDCs at market interest rates to be paid over 10 or 20 
years.[Footnote 24] The 504 CDCs provide small businesses with fixed-
rate, long-term loans, primarily for buildings, land, equipment, and 
machinery (not to exceed 40 percent of the total project cost). A 
private lender must provide at least 50 percent of the project cost. 
According to SBA officials, the lenders benefit from SBA's guarantee 
because they are in a first lien position, which lessens their credit 
risk. Under the Microloan program, SBA guarantees loans that are made 
to intermediaries by private sector lenders.

* Finally, the Financial Assistance component of the CDFI Fund offers 
grants, loans, and equity investments to CDFI lenders. However, lenders 
must obtain nonfederal matching funds in a form and value similar to 
the CDFI Fund's award. For instance, a lender receiving a grant award 
from the CDFI Fund must match the award dollar for dollar with other 
grant money. Likewise, lenders receiving loan and equity awards must 
match the loan dollar for dollar with other loan and equity money.

The programs also varied in whether and how they target geographic 
areas, borrowers, or businesses. Table 3 illustrates the range of 
geographic areas targeted by the programs in our review. For example, 
both USDA programs target rural areas, the ARC program targets 
Appalachia, and other programs target eligible areas that they define 
as economically distressed.[Footnote 25] Similarly, table 3 shows that 
many of the programs we reviewed require that eligible borrowers create 
jobs or otherwise improve economic conditions in the areas that the 
borrower's business or project will impact.[Footnote 26] Likewise, some 
programs have established target eligibility criteria for borrowers 
that include credit qualifications. For example, in EDA's Economic 
Adjustment Assistance Program, borrowers are not eligible unless they 
are unable to obtain a loan with acceptable terms and conditions from a 
traditional lending institution. Finally, some programs limit 
eligibility to specific types of borrowers. For instance, SBA's 
Microloan program requires that borrowers be small, for-profit 
businesses.[Footnote 27]

Table 3: Summary of Programs and Their Target Market Criteria:

Federal program: Intermediary Relending Program (USDA IRP); Targeting 
criteria: Geographic areas: Yes; Targeting criteria: Low income 
populations: No; Targeting criteria: Job creation and 
preservation: Yes; Targeting criteria: Borrower credit: Yes; Types of 
entities supported: Start-up, expansion of existing businesses.

Federal program: Rural Business Enterprise Grant (USDA RBEG); Targeting 
criteria: Geographic areas: Yes; Targeting criteria: Low income 
populations: No; Targeting criteria: Job creation and 
preservation: Yes; Targeting criteria: Borrower credit: No; Types of 
entities supported: Start-up, expansion of existing businesses.

Federal program: Economic Adjustment Assistance Revolving Loan Fund 
(EDA RLF); Targeting criteria: Geographic areas: Yes; Targeting 
criteria: Low income populations: No; Targeting criteria: Job creation 
and preservation: Yes; Targeting criteria: Borrower credit: Yes; Types 
of entities supported: Start-up, expansion of existing businesses.

Federal program: Business Development Revolving Loan Fund (ARC RLF); 
Targeting criteria: Geographic areas: Yes; Targeting criteria: Low 
income populations: Yes; Targeting criteria: Job creation and 
preservation: Yes; Targeting criteria: Borrower credit: Yes; Types of 
entities supported: Start-up, expansion of existing businesses.

Federal program: Community Development Block Grant (CDBG); Targeting 
criteria: Geographic areas: No; Targeting criteria: Low income 
populations: Yes; Targeting criteria: Job creation and preservation: 
No; Targeting criteria: Borrower credit: No; Types of 
entities supported: Various for-profit or nonprofit businesses.

Federal program: Section 108 Loan Guarantee; Targeting criteria: 
Geographic areas: No; Targeting criteria: Low income populations: 
Yes; Targeting criteria: Job creation and preservation: No; 
Targeting criteria: Borrower credit: No; Types of entities 
supported: Various for-profit or nonprofit businesses.

Federal program: Community Services Block Grant; (CSBG); Targeting 
criteria: Geographic areas: No; Targeting criteria: Low income 
populations: Yes; Targeting criteria: Job creation and preservation: 
Yes[A]; Targeting criteria: Borrower credit: No; Types of entities 
supported: Start-up, expansion of existing businesses.

Federal program: Enterprise Community/; Empowerment Zone Grant (EZ/EC); 
Targeting criteria: Geographic areas: Yes; Targeting criteria: Low 
income populations: Yes; Targeting criteria: Job creation and 
preservation: Yes; Targeting criteria: Borrower credit: No; Types of 
entities supported: Various.

Federal program: Financial Assistance component of CDFI Fund; Targeting 
criteria: Geographic areas: Yes; Targeting criteria: Low income 
populations: Yes; Targeting criteria: Job creation and preservation: 
No; Targeting criteria: Borrower credit: No; Types of 
entities supported: Various.

Federal program: 504 Certified Development Company (504 CDC); Targeting 
criteria: Geographic areas: Yes; Targeting criteria: Low income 
populations: No; Targeting criteria: Job creation and 
preservation: Yes; Targeting criteria: Borrower credit: Yes; Types of 
entities supported: Small, for-profit businesses.

Federal program: Microloan Direct and Loan Guarantee programs; 
Targeting criteria: Geographic areas: Yes; Targeting criteria: Low 
income populations: Yes; Targeting criteria: Job creation and 
preservation: No; Targeting criteria: Borrower credit: Yes; Types of 
entities supported: Small, for-profit businesses.

Sources: Federal program documents and Catalog of Federal Domestic 
Assistance.

[A] Illinois CSBG program requires borrowers to hire at least one new 
full-time equivalent CSBG eligible employee for each $20,000, or any 
portion thereof, of CSBG monies borrowed.

[End of table]

Federal Programs Differ in Size, Level of Activity:

In general, as shown in table 4, programs ended fiscal years 1998--2003 
with lower funding levels than they began. In the most recent three 
years, the Section 108 and 504 CDC loan guarantee programs, which 
securitize CED loans, have required less funding than most other CED 
programs. In these years, the 504 CDC had no appropriations because the 
present value of the estimated cash inflows from fees and recoveries 
equaled the estimated cash outflows from claims. Table 4 illustrates 
the levels of appropriations for those programs where data were 
available for fiscal years 1998--2003.

Table 4: Appropriations for CED Lending Have Declined in Selected 
Federal Programs (Fiscal Years 1998-2003):

Dollars in millions.

EDA--RLF Grant[A]; 1998: $29.9; 1999: $34.6; 2000: $34.6; 2001: $49.5; 
2002: $40.9; 2003: (estimate): 40.6.

Treasury--CDFI (FA) [B]; 1998: 43.0; 1999: 75.8; 2000: 66.8; 2001: 
47.1; 2002: 34.3; 2003: (estimate): 31.8.

HUD--Section 108 Loan Guarantee[C]; 1998: 9.0; 1999: 10.0; 2000: 29.0; 
2001: 29.0; 2002: 14.0; 2003: (estimate): 6.0.

SBA--504 CDC Loan Guarantee[C]; 1998: 166.0; 1999: 34.0; 2000: 5.0; 
2001: 0; 2002: 0; 2003: (estimate): 0.

USDA--IRP Loan; 1998: 17.0; 1999: 17.0; 2000: 17.0; 2001: 19.0; 2002: 
13.0; 2003: (estimate): 20.0.

SBA--Microloan Direct Loan[D]; 1998: 0; 1999: 2.0; 2000: 2.0; 2001: 
3.0; 2002: 1.0; 2003: (estimate): 4.0.

Sources: Federal Budget Appendixes for 1998 through 2004 and federal 
agency data.

Note: Six programs were unable to provide information on the dollar 
amount of annual appropriations used to capitalize CED lenders. HUD 
CDBG (State-Administered and Entitlement Cities) and HHS EZ/EC programs 
do not allocate appropriations by type of activity (that is CED 
lending) funded. The USDA RBEG program does not receive an earmark in 
appropriations for RLF spending. RBEG recipients may use the funds for 
a variety of purposes, including capitalization of an RLF. 
Appropriations for the HHS CSBG program were not included because, as 
noted elsewhere in this section, according to HHS officials, Illinois 
is the only state known to use CSBG funds for CED lending purposes. ARC 
receives one appropriation to support all administrative and 
programmatic activity. Hence, there is no budget specifically for the 
Business Development Revolving Loan Fund program. The appropriation is 
allocated amongst the 13 states, and the commission decides to approve 
the funding for individual plans submitted by states based upon how the 
proposed project meets the agency's mission strategy.

[A] Only includes funds for RLFs that help communities adjust to sudden 
and severe economic dislocation (SSED/RLFs), and long term economic 
deterioration (LTED/RLFs). Does not include grant funds used for 
defense and disaster assistance. Appropriated funds for these other 
types of economic adjustment grants varies from year-to-year and has 
declined in recent years.

[B] Includes grants, loans, and equity investments made from the CDFI 
Fund.

[C] Appropriations for loan and loan guarantee programs are based on 
assumptions regarding the performance of the loans. The ultimate cost 
to the government could be higher or lower if actual loan performance 
differs from these assumptions.

[D] Appropriations for the SBA Microloan loan guarantees were zero for 
all fiscal years 1998-2002 and the 2003 estimate, except in fiscal year 
2000, when SBA did not report the budget authority for the program. 
However, fiscal year 2000 outlays for the SBA Microloan loan guarantees 
were $1 million.

[End of table]

The federal programs we reviewed also differed in the number of lenders 
participating in the program, ranging from as few as 35 lenders in 
ARC's Business Development program, to as many as 546 in EDA's Economic 
Adjustment Assistance RLF program. Most of the programs were able to 
provide information on the number of lenders and the number and dollar 
volume of program awards--whether loans or grants--made to CED lenders. 
HUD CDBG and HHS EZ/EC and CED programs were the only exceptions. The 
two loan guarantee programs, 504 CDC and Section 108, issue notes that 
are sold to investors. The volume of loan guarantee commitments is 
noted in table 5. We found that there was a great deal of variation in 
the level of program activity between these programs.

Table 5: Number of Lenders and Dollar Volume of Federal Support (Fiscal 
Years 1998-2002)[A]:

Federal program (agency): Intermediary Relending Program (USDA); FY 
1998-2002[B]: Number of lenders supported: 273; FY 1998-2002[B]: Dollar 
volume of support (in millions): $167.5.

Federal program (agency): Rural Business Enterprise Grant (USDA); FY 
1998-2002[B]: Number of lenders supported: 364; FY 1998-2002[B]: Dollar 
volume of support (in millions): 45.6.

Federal program (agency): Economic Adjustment Assistance (EDA)[C]; FY 
1998-2002[B]: Number of lenders supported: 546; FY 1998-2002[B]: Dollar 
volume of support (in millions): 24.4.

Federal program (agency): Business development program (ARC); FY 1998-
2002[B]: Number of lenders supported: 35; FY 1998-2002[B]: Dollar 
volume of support (in millions): 33.7.

Federal program (agency): Section 108 loan guarantee (HUD)[ D]; FY 
1998-2002[B]: Number of lenders supported: N/A; FY 1998-2002[B]: Dollar 
volume of support (in millions): 1,800.7.

Federal program (agency): Community Services Block Grant (CSBG-
Illinois); FY 1998-2002[B]: Number of lenders supported: 38; FY 1998-
2002[B]: Dollar volume of support (in millions): 49.0.

Federal program (agency): Financial Assistance (FA) component of CDFI 
Fund (Treasury)[E]; FY 1998-2002[B]: Number of lenders supported: N/A; 
FY 1998-2002[B]: Dollar volume of support (in millions): 303.0.

Federal program (agency): 504 CDC program (SBA); FY 1998-2002[B]: 
Number of lenders supported: 272; FY 1998-2002[B]: Dollar volume of 
support (in millions): 11,524.0.

Federal program (agency): Microloan program Direct Loans (SBA)[F]; FY 
1998-2002[B]: Number of lenders supported: 174; FY 1998-2002[B]: Dollar 
volume of support (in millions): 111.2.

Source: Federal agency data.

Note: N/A data is not available.

[A] Federal support may consist of grants, loans, loan guarantee 
commitments, and other investments. For loans and loan guarantees, the 
amount shown is the face value of the loan.

[B] Business development program (ARC) covers FY 1977 through February 
14, 2003, and the Illinois CSBG program covers FY 1984-2002.

[C] Data on the number of lenders supported by EDA's Economic 
Adjustment Assistance program covers the period 1975-2002, and includes 
Disaster Assistance and Defense RLFs. However, dollar volume amounts 
cover the period noted in the table (1998-2002), and reflect grants 
made to SSED and LTED RLFs only.

[D] A Section 108 grantee may reloan the proceeds of a loan guarantee 
to fund loans to a third-party borrower either directly or through a 
nonprofit intermediary (i.e., a RLF or CDC).

[E] CDFI's Financial Assistance includes core and intermediary 
component programs. These amounts include grants, loans, deposits, and 
equity investments.

[F] Amounts for SBA's Microloan program include support for direct 
loans only, not loan guarantees.

[End of table]

Several Programs Have Considered Securitization:

Several of the programs in our review have studied or are presently 
undertaking securitization efforts. For example, Treasury's CDFI Fund 
recently commissioned a survey of its member CDFIs to study the 
feasibility of developing the secondary market for loans made by its 
members. In 1999, EDA initiated a demonstration project that provided 
financial assistance to support RLFs wishing to securitize a portion of 
their loan portfolio. The pilot resulted in three RLFs successfully 
securitizing or selling loans. In addition to the Section 108 loans HUD 
currently securitizes, HUD sponsored a study to collect extensive 
information on the loans made by its CDBG and Section 108 awardees to 
third-party businesses and nonprofit organizations, in part to assess 
the potential for creating a secondary market for these loans. Other 
programs have made some efforts to determine the feasibility of 
securitizing loans made by their lenders. In 1999, the ARC program 
removed language from its guidance allowing its RLFs to sell their 
loans. Officials noted that grantees were uninterested in 
securitization for several reasons, including grantees' easy access to 
additional capital through the ARC grants. After a successful sale of 
IRP loans made in Colorado, in November 1999, USDA piloted a first 
attempt to sell IRP loans nationally. According to USDA officials, the 
pilot generated little interest because of the strict requirements for 
lender participation. To date, USDA has not established formal 
regulations to support securitization. SBA securitizes 504 CDC loans. 
Finally, our review also found that some programs have prohibitive or 
inhibitive program requirements governing the use of the funds that 
limit lenders' ability to securitize their loans. We address this issue 
in more detail later in the report.

Federal Programs Vary in Efforts to Collect and Maintain Information on 
Lender Activity and Loan Performance:

The programs differed in the type of information they collected on 
lender activity, the performance of lenders' loan portfolios, and how 
the information was maintained. Information that lenders were required 
to report also varied widely. For example, the CDFI Fund requires 
lenders to report on the amount, number, and type of loans that CDFI 
lenders make. In contrast SBA's Microloan program required information 
on account activity supported by bank statements, as well as an account 
of the status of each loan in the portfolio. Other items that some 
programs required lenders to report included the financial condition of 
the lender and impact information--such as the number of jobs created 
and retained.

In addition, the frequency of reporting required by lenders differed by 
program. Three programs--USDA's IRP, RBEG and SBA's Microloan--required 
that lenders submit quarterly reports; two programs--EDA RLF[Footnote 
28] and ARC's Business Development--required semiannual reports; and 
six--504 CDC, CDBG, EZ/EC, CSBG, CDFI, and Section 108--required annual 
reports.

Further, our review found that regardless of how data are collected, 
there is little information about the volume of lending activity 
supported by and loan performance of some of the programs in our 
review. Programs in EDA, ARC, and Treasury required that lenders 
provide ongoing information on the loans in their portfolios, often 
including the loan amount, term, interest rate, and losses.[Footnote 
29] However, as mentioned earlier, they are not consistently defined, 
and do not all contain information at the loan-level. Further, four of 
the programs in HUD, EDA and Treasury only recently began collecting 
loan-level information because they undertook one-time, loan-level data 
collection efforts.[Footnote 30]

Finally, these programs differed in whether they maintained performance 
information on paper or in a database and whether the files were kept 
in a central location or office. Only programs in Treasury maintained 
lender and loan information in a database, and only programs in ARC and 
Treasury maintained annual report information on lenders and their 
loans in a central location.[Footnote 31]

Selected Securitization Models for Small Business and CED Loans Have 
Similarities and Differences:

We reviewed five existing and three proposed securitization models 
designed to provide greater access to capital for small business and 
CED lenders. Each of the eight models exhibit similarities and 
differences in terms of (1) the types of lenders and borrowers served, 
(2) the types of loans pooled and methods for pooling, (3) the 
distribution of financial benefits and risks among participants, and 
(4) their outstanding securitized volumes. Less is known about the 
proposed securitization models since they do not currently engage in 
market transactions.

Types of Lenders and Borrowers Served Vary:

As shown in table 6, these models serve, or would serve, private, 
nonprofit, and governmental lenders. For example, the two models 
securitizing SBA's 7(a) guaranteed and unguaranteed loans serve mostly 
depository lenders such as commercial banks and some nondepository 
lenders such as finance companies. The SBA 504 program serves only 
private nonprofit corporations called CDCs, while the existing and 
proposed Section 108 models serve or would serve CDBG-funded state and 
local governments and development agencies. The Community Reinvestment 
Fund (CRF) may serve nonprofit, for-profit, and governmental community 
development lenders eligible to sell loans. Similarly, the proposed CDA 
model would serve those lenders eligible to sell loans.

Table 6 also shows a wide variety of borrowers served by these models. 
For example, the SBA 504 model finances small businesses who have 
qualified for conventional loans backed by commercial real estate loans 
with senior bank participation, whereas the CRF model has provided 
financing to businesses ranging from start-up microenterprises to 
marginal for-profit and nonprofit borrowers. While all models generally 
loan to for-profit businesses, some are restricted to small businesses 
(SBA models) and others may also serve nonprofit borrowers (CRF and 
Capital Access models).

Table 6: Securitization Models and Lenders and Borrowers Involved:

Model: SBA 504 Program; guaranteed; Lenders: Certified Development 
Companies; Borrowers: For-profit small businesses that have qualified 
for conventional loans.

Model: SBA 7(a) guaranteed; Lenders: Commercial banks, credit unions, 
small business lending companies and other nonbank lenders; Borrowers: 
For-profit small businesses that have demonstrated they could not 
obtain financing without the 7(a) program.

Model: SBA 7(a) unguaranteed; Lenders: Commercial banks, credit unions, 
small business lending companies and other nonbank lenders; Borrowers: 
For-profit small businesses that have demonstrated they could not 
obtain financing without the 7(a) program.

Model: HUD Section 108 guaranteed; Lenders: CDBG grantees and their 
designated lenders; Borrowers: For-profit or nonprofit borrower.

Model: Community Reinvestment Fund (CRF); Lenders: Nonprofit, for-
profit, and governmental CED lenders; Borrowers: Local business, 
affordable housing, and community facility borrowers.

Model: Proposed Commonwealth Development Associates (CDA); Lenders: 
Nonprofit, for-profit, and governmental CED lenders; Borrowers: Small 
business borrowers not served by local commercial financial 
institutions.

Model: Proposed; CDBG/108 unguaranteed; Lenders: CDBG grantees and 
their designated lenders; Borrowers: For-profit or nonprofit borrower.

Model: Proposed; Capital Access Program variation; Lenders: CDFI 
lenders; Borrowers: Minority businesses, nonprofits, commercial real 
estate.

Sources: SBA, HUD, CRF, CDA, Capital Access Group.

[End of table]

Types of Loans Pooled and Methods for Pooling Vary:

These models securitize a variety of loan products to serve the 
borrowers and lenders described above. Table 7 details similarities and 
differences in the type and characteristics of loans that may be pooled 
in each model, including loan purpose, collateral positions, loan 
terms, and rates. For example, while each of the models accepts 
commercial real estate and business equipment loans into their loan 
pools, the models vary in their acceptance of working capital and 
community facility loans. Additionally, senior or subordinate 
collateral positions on these loans vary by model. For instance, the 
two SBA 7(a) models prohibit subordinate loans, while the SBA 504 and 
Capital Access models allow only subordinate loans. One proposed model, 
CDA, would only purchase seasoned loans rather than committing in 
advance to securitizing loans meeting certain underwriting standards. 
Terms of the loans that each model may accept vary slightly; all of the 
models would purchase long-term loans between 10 and 20 years, but only 
one model--the SBA 504 model--does not purchase loans with maturities 
less than 10 years. Variation in loan rates also exists. For instance, 
all of the models allow fixed-rate loans to be purchased, but three of 
the models prohibit variable-rate loans. Most of the loans securitized 
by the two SBA 7(a) models included variable-rate loans. Four of the 
models purchase or would purchase only market-rate loans. Two purchase 
or would purchase market and below-market-rate loans, and the remaining 
two models purchase below-market-rate loans only. While data on average 
loan size was not readily available for most models, the two models 
that provided this information demonstrated a wide divergence in 
average loan sizes: $165,000 for the SBA 7(a) loans in fiscal year 2003 
compared with $1.5 million for the Section 108 Loan Guarantee program 
since 1995.

Table 7: Types of Loans Pooled Varies by Model:

Types of loans: 

Commercial real estate; SBA 504 Program: Yes[A]; SBA 7(a) guaranteed: 
Yes; SBA 7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; 
Community Reinvestment Fund: Yes; Proposed models: Commonwealth 
Development Associates: Yes; Proposed models: CDBG/Section 108: Yes; 
Proposed models: Capital Access program variation: Yes.

Community facilities; SBA 504 Program: No; SBA 7(a) guaranteed: No; 
SBA 7(a) unguaranteed: No; HUD Section 108 guaranteed: No; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: No; Proposed models: CDBG/Section 108: No; Proposed 
models: Capital Access program variation: No.

Business equipment; SBA 504 Program: Yes[B]; SBA 7(a) guaranteed: Yes; 
SBA 7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: Yes.

Loan position: 

Working capital; SBA 504 Program: No; SBA 7(a) guaranteed: Yes; SBA 
7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: No; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: Yes.

Senior collateral position; SBA 504 Program: No; SBA 7(a) guaranteed: 
Yes; SBA 7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; 
Community Reinvestment Fund: Yes; Proposed models: Commonwealth 
Development Associates: Yes; Proposed models: CDBG/Section 108: Yes; 
Proposed models: Capital Access program variation: No.

Junior collateral position; SBA 504 Program: Yes; SBA 7(a) guaranteed: 
No; SBA 7(a) unguaranteed: No; HUD Section 108 guaranteed: Yes; 
Community Reinvestment Fund: Yes; Proposed models: Commonwealth 
Development Associates: Yes; Proposed models: CDBG/Section 108: Yes; 
Proposed models: Capital Access program variation: Yes.

Loan maturity: 

Less than 10 years; SBA 504 Program: No; SBA 7(a) guaranteed: Yes; SBA 
7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: Yes.

10 to 20 years; SBA 504 Program: Yes[C]; SBA 7(a) guaranteed: Yes; SBA 
7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: Yes.

Loan Interest Rates: 

Fixed; SBA 504 Program: Yes; SBA 7(a) guaranteed: Yes; SBA 7(a) 
unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: Yes.

Variable; SBA 504 Program: No; SBA 7(a) guaranteed: Yes; SBA 7(a) 
unguaranteed: Yes; HUD Section 108 guaranteed: Yes[D]; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: No; Proposed models: CDBG/Section 108: No; Proposed 
models: Capital Access program variation: No.

Market rate; SBA 504 Program: Yes; SBA 7(a) guaranteed: Yes; SBA 7(a) 
unguaranteed: Yes; HUD Section 108 guaranteed: No; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: No; Proposed 
models: Capital Access program variation: Yes.

Below market rate; SBA 504 Program: No; SBA 7(a) guaranteed: No; SBA 
7(a) unguaranteed: No; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: Yes; Proposed 
models: Capital Access program variation: No.

Underwriting Criteria: 

Advance loans; SBA 504 Program: Yes; SBA 7(a) guaranteed: No; SBA 
7(a) unguaranteed: No; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: No; Proposed models: CDBG/Section 108: unknown; Proposed 
models: Capital Access program variation: Yes.

Seasoned loans; SBA 504 Program: No; SBA 7(a) guaranteed: Yes; SBA 
7(a) unguaranteed: Yes; HUD Section 108 guaranteed: Yes; Community 
Reinvestment Fund: Yes; Proposed models: Commonwealth Development 
Associates: Yes; Proposed models: CDBG/Section 108: unknown; Proposed 
models: Capital Access program variation: No.

Sources: SBA, HUD, CRF, CDA, Capital Access Group.

[A] 90 percent of all loans.

[B] 10 percent of all loans.

[C] 90 percent of loans are 20 years.

[D] For interim financing only.

[End of table]

Only SBA's 7(a) models and CRF hold loans on balance sheets of the pool 
assemblers until they assemble enough loans to pool and securitize. 
Other models predetermine the timing of their securities issuances, and 
sometimes their loan originations, in advance. For example, SBA's 504 
program anticipates regular and predictable monthly issuances of its 
20-year securities backed by CDC-originated, SBA-guaranteed loans. The 
Section 108 Loan Guarantee model also issues notes to investors in a 
regular and predictable manner--each year at the beginning of August. 
In between these public offerings, HUD provides interim variable-rate 
financing to CDBG grantees through a money market fund in Pittsburgh. 
(Appendix II contains brief descriptions of the structures for each 
securitization model.):

Distribution of Risks and Benefits Vary among Models:

As explained in the following sections, models distribute interest rate 
risk (the risk of financial loss due to changes in market interest 
rates) and credit risks (the risk of financial loss due to borrower 
default) among various participants differently. Benefits of various 
securitization models also vary among participants.

Interest Rate Risks Are Distributed Differently:

The models distribute interest rate risk differently among 
participants, depending on whether loans allowed in the loan pool are 
fixed-rate or variable-rate, whether or not loans are held for 
extensive periods of time by lenders and loan pool assemblers until 
they can be sold (warehousing) to investors, and how these participants 
fund the loans they hold. Interest rate risk for lenders, loan pool 
assemblers, and investors depends on the terms to maturity of their own 
assets and liabilities, and their interest rates. For example, an 
investor in a long-term, fixed-rate asset would not face interest rate 
risk if this asset was funded with a long-term, fixed-rate liability 
with the same term. Such asset funding would lock in an interest spread 
(interest earned on the asset or interest paid on the liability) and 
negate the impact of interest rate movements on earnings. However, an 
investor that funds long-term, fixed-rate assets with short-term 
liabilities would face interest rate risk because a future increase in 
interest rates could require the investor to roll over the short-term 
liability when it came due into a higher-rate, short-term liability and 
narrow or reverse the interest rate spread. Similarly, a variable-rate 
asset if funded by a variable-rate liability with a lower rate would 
curtail interest rate risk. However, funding a variable-rate asset with 
a fixed-rate liability would create interest rate risk. A future 
increase in the variable rate on the liability above the fixed rate on 
the asset could create a negative spread. Borrowers of variable-rate 
loans could find their cost of borrowing becoming less affordable if 
interest rates increased, but could benefit from declines in interest 
rates. Borrowers of fixed-rate loans benefit when interest rates rise, 
but because business borrowers typically are penalized for prepaying 
loans, they may not benefit from declines in interest rates.

Credit Risks Are Distributed Differently:

Credit risk is also distributed differently among participants in the 
models we reviewed. Investors assume limited or no risk relative to 
other participants, depending upon the amount and type of credit 
enhancements included in each model. As shown in table 8, all models 
use some form of internal (assumed by the lender, borrower, or 
securitizer) or external (third-party) credit enhancement to determine 
the credit risk assumed by all participants. The three models where the 
federal government assumes all credit risk require no additional 
internal or external credit enhancement. The five models where the 
federal government takes little or no credit risk result in other 
participants (usually lenders) assuming credit risks through internal 
credit enhancements. CRF uses, and CDA proposed, multiple internal and 
external credit enhancements. CRF, a nonprofit, uses foundation grants 
and program-related investments to fund some of its credit 
enhancements.[Footnote 32] The CDA model envisions a similar credit 
enhancement structure using public or private funding. Finally, while 
the Capital Access model does not specifically propose a publicly 
funded credit enhancement, virtually all 20 states that currently have 
Capital Access lending programs do provide state funding to loan loss 
reserve funds assigned to each participating lender, which may be used 
as credit enhancements if authorized by state law.

Credit enhancements can take a variety of forms. External credit 
enhancements rely on third parties to provide additional assurance of 
timely payment of principal and interest to investors. These 
enhancements can be governmentally provided (for example, loan 
guarantees) or privately provided (for example, loan guarantee 
insurance or letters of credit). With external enhancements, the credit 
quality and expected performance of the asset pool is often based on 
the credit quality of the external enhancement provider. Internal 
credit enhancements are not dependent on third parties and are often 
funded by lenders. These enhancements include senior or subordinate 
positions, in which cash flows from the pool of assets are structured 
so that the higher credit quality "senior" securities would fail to 
receive timely cash flows only after lower credit quality subordinated 
securities fail to receive their cash flows. Internal enhancements also 
include over-collateralization, in which the face value of the assets 
in the pool are greater than the face value of securities issued; 
excess spread, in which the difference between the cash flowing into an 
asset pool and the cash flowing out of a pool to security holders is 
set aside in a reserve fund to cover future, unexpected payment delays 
or losses; and loan loss reserves, in which monies are set aside to 
cover future unexpected cash flow delays or losses. Occasionally, such 
as with CRF, loan originators may be required to replace nonperforming 
loans with performing loans according to loan substitution agreements. 
Lender recourse are financial obligations of lenders to make a loan 
pool whole if the portion of the loan pool provided by that lender 
fails to perform.

Table 8: Credit Enhancements Used to Distribute Credit Risks Vary by 
Model:

Credit enhancement type: External: Governmental; SBA 504 Program: Yes; 
SBA 7(a) guaranteed: Yes; SBA 7(a) unguaranteed: No; HUD Section 108 
guaranteed: Yes; Community Reinvestment Fund: No; Proposed models: 
Common-wealth Development Associates: Yes; Proposed models: CDBG/
Section 108: No; Proposed models: Capital Access Program 
Variation: No.

Credit enhancement type: External: Private; SBA 504 Program: No; 
SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: No; HUD 
Section 108 guaranteed: No; Community Reinvestment Fund: Yes[A]; 
Proposed models: Common-wealth Development Associates: Yes; Proposed 
models: CDBG/Section 108: No; Proposed models: Capital Access 
Program Variation: No.

Credit enhancement type: Internal: Senior/subordinate; SBA 504 
Program: No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: 
Yes; HUD Section 108 guaranteed: No; Community Reinvestment Fund: Yes; 
Proposed models: Common-wealth Development Associates: Yes; Proposed 
models: CDBG/Section 108: Yes; Proposed models: Capital Access Program 
Variation: No.

Credit enhancement type: Internal: Overcollateralization; SBA 504 
Program: No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: 
No; HUD Section 108 guaranteed: No; Community Reinvestment 
Fund: Yes; Proposed models: Common-wealth Development Associates: Yes; 
Proposed models: CDBG/Section 108: No; Proposed models: Capital 
Access Program Variation: No.

Credit enhancement type: Internal: Excess spread; SBA 504 Program: 
No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: Yes; HUD 
Section 108 guaranteed: No; Community Reinvestment Fund: Yes; 
Proposed models: Common-wealth Development Associates: No; 
Proposed models: CDBG/Section 108: No; Proposed models: Capital 
Access Program Variation: No.

Credit enhancement type: Internal: Loan loss reserve; SBA 504 Program: 
No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: No; 
HUD Section 108 guaranteed: No; Community Reinvestment Fund: Yes; 
Proposed models: Common-wealth Development Associates: Yes; Proposed 
models: CDBG/Section 108: Yes; Proposed models: Capital Access Program 
Variation: Yes.

Credit enhancement type: Internal: Recourse to lender; SBA 504 Program: 
No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: No; 
HUD Section 108 guaranteed: No; Community Reinvestment Fund: Yes; 
Proposed models: Common-wealth Development Associates: No; 
Proposed models: CDBG/Section 108: No; Proposed models: Capital 
Access Program Variation: No.

Credit enhancement type: Internal: Loan substitution; SBA 504 Program: 
No; SBA 7(a) guaranteed: No; SBA 7(a) unguaranteed: No; 
HUD Section 108 guaranteed: No; Community Reinvestment Fund: Yes; 
Proposed models: Common-wealth Development Associates: Yes; Proposed 
models: CDBG/Section 108: No; Proposed models: Capital Access 
Program Variation: No.

Privately or publicly placed[B]: 
SBA 504 Program: Privately or publicly placed[B]: Public; SBA 7(a) 
guaranteed: Privately or publicly placed[B]: Public; SBA 7(a) 
unguaranteed: Privately or publicly placed[B]: Public or private; 
HUD Section 108 guaranteed: Privately or publicly placed[B]: 
Public; Community Reinvestment Fund: Privately or publicly placed[B]: 
Private; Proposed models: Common-wealth Development 
Associates: Privately or publicly placed[B]: Private; Proposed 
models: CDBG/Section 108: Privately or publicly placed[B]: Not 
specified; Proposed models: Capital Access Program Variation: 
Privately or publicly placed[B]: Private.

Credit Rating: SBA 504 Program: No; Credit Rating: SBA 
7(a) guaranteed: No; Credit Rating: SBA 7(a) 
unguaranteed: Yes; Credit Rating: HUD 
Section 108 guaranteed: No; Credit Rating: Community Reinvestment 
Fund: No; Credit Rating: Proposed models: Common-wealth 
Development Associates: Yes; Credit Rating: Proposed models: 
CDBG/Section 108: Yes; Credit Rating: Proposed models: Capital Access 
Program Variation: No.

Sources: SBA, HUD, CRF, CDA, Capital Access Group.

[A] In addition to external foundation monies, CRF may attempt a rated 
security that will include some external guarantee insurance on the 
senior tranche securities.

[B] Public offerings of securities must meet Securities and Exchange 
Commission (SEC) registration and disclosure requirements. In a private 
placement, securities issuers can avoid the costs of the registration 
and reporting process required of a public offering as long as there is 
no solicitation of the public, the investors are sophisticated in 
business matters, and investors have access to certain information.

[End of table]

Benefits Are Distributed Differently:

These securitization models distribute benefits differently among 
participants. Investors can diversify their portfolios with new 
securities that have desirable risk, return, and maturity 
characteristics. For example, a number of institutional investors, 
particularly state or local and religious pension funds have been 
investing in "socially responsible" investments for over two decades, 
provided they could achieve market-rate returns with sufficient loss 
protection to satisfy their "prudent person" investment 
requirements.[Footnote 33] As noted earlier, pension funds hold longer-
term, fixed-rate investments for portfolio management purposes. These 
models provide lenders opportunities to better manage their risk and 
financial positions by selling certain loans they have originated from 
their portfolios and to further their missions by replenishing capital 
available for new loans or other purposes. For example, CRF's ability 
to warehouse CED loans improves CED lenders' ability to sell loans on 
occasions when the benefits of selling the CED loans are most clearly 
visible to CED lenders. SBA's attempts at regular and predictable 
monthly issuances of its securities backed by SBA-guaranteed 504 loans 
allows a more consistent mechanism for 504 CDCs to sell loans, rather 
than hold long-term loans in their portfolios thereby freeing their 
capital for other purposes. Borrowers in each of the models benefit 
from access to capital that would otherwise be unavailable.

Volume of Outstanding Securitized Loans Have Not Reached the Volume of 
More Well-Established Models:

Figure 3 shows the total amount of outstanding securitized loans for 
well-established securitization models versus models for securitizing 
CED loans. Models with assets such as home mortgages, commercial 
mortgages, or consumer financings show the greatest amount of 
outstanding securitized loans. These models have been in existence for 
many years. Conventional home mortgages, for example, have been 
securitized for over 30 years. These industries have developed 
standards for documents and underwriting that enable wider 
securitization. The existing CED models we reviewed have not reached 
the level of securitization of the more well-established models. Among 
the CED models, the two SBA guaranteed models have a far greater amount 
of outstanding securitized loans than the other three models--7(a) 
unguaranteed, Section 108 guaranteed, and CRF.

Figure 3: Levels of Outstanding Securitized Loans Have Not Reached the 
Levels of More Well-Established Models:

[See PDF for image]

[A] Federal Reserve Bulletin, Table A33, July 2003. Outstanding 
principal balances of Federal National Mortgage Association (Fannie 
Mae), Federal Home Loan Mortgage Association (Freddie Mac), and 
Government National Mortgage Association (Ginnie Mae) guaranteed or 
insured mortgage-backed securities. Includes one-to four-family 
mortgages.

[B] Federal Reserve Bulletin, Table A33, July 2003. Outstanding 
principal balances of mortgage-backed securities issued through private 
mortgage conduits. Includes one-to four-family mortgages.

[C] Federal Reserve Bulletin, Table A33, July 2003. Outstanding 
principal balances of nonfarm, nonresidential, mortgage-backed 
securities issued through private mortgage conduits.

[D] Federal Reserve Bulletin, Table A34, July 2003. Includes 
outstanding balances of all pools of securitized credits, including 
revolving and nonrevolving credit.

[E] SBA reported data as of September 30, 2002.

[F] SBA reported data as of September 30, 2002.

[G] SBA reported data as of September 30, 2002. This number represents 
loan balances at the time of securitization, not outstanding loan 
balances as of September 30, 2002.

[H] HUD reported data as of August 29, 2003.

[I] CRF reported data as of December 31, 2002. This number represents 
loan balances at the time of securitization, not outstanding loan 
balances as of December 31, 2002. This number excludes notes backed by 
roughly $41 million (loan balances at the time of securitization) of 
CED loans that were not issued through a special purpose vehicle. As of 
December 2002, these notes had an outstanding principal balance of 
about $1 million.

[End of figure]

We Identified Barriers to Securitizing CED Loans:

We identified six categories of barriers for either lenders or capital 
markets investors in securitizing CED loans. First, uncertain borrower 
demand exists across targeted markets, and CED lenders generally lack 
incentives to participate in securitization. Second, management 
capacity for securitizing loans is limited. Third, external 
requirements attached to funding sources may directly or indirectly 
inhibit the securitization of CED loans. Fourth, CED lenders believe 
that selling below-market-rate loans would require them to absorb too 
high a discount to profit from a securitization. Fifth, lack of lender 
product standardization, documentation, and loan performance 
information impedes securitization by increasing transaction costs. 
Finally, mechanisms available to support securitization for CED loans 
are limited.

Uncertain Borrower Demand and Limited Lender Interest Limit the Ability 
to Securitize:

According to studies, lenders, programs, and their associations, 
current and future borrower demand is not understood across target 
markets, and CED lenders do not see the benefit of securitization. 
Borrower demand--borrower's need for capital in target markets served, 
given the risk levels lenders can absorb--is not understood by lenders, 
programs, and capital market participants across target markets because 
it can be volatile and is not consistently measured. In some federal 
programs, for instance, measurements of current borrower demand are 
assessed through lender annual reports. Other programs and their 
lenders also use proxy measurements of demand.[Footnote 34] In 
addition, there are no mechanisms or standards for forecasting future 
borrower demand for such loans, making it difficult to determine what 
borrower demand might be across markets. Moreover, borrower demand is 
unpredictable, in part due to changes in local conditions in some 
markets. For some targeted communities, the favorable economic climate 
of the 1990s prompted conventional lenders to move down market (that 
is, lend to more risky borrowers), thereby pushing demand for CED loans 
into areas where CED lenders were less willing to take on further risk.

According to several CED lenders, securitization studies, and reviews 
of federal agency securitizations, lenders lack incentive to 
participate in securitizations. For instance, EDA's securitization 
pilot study found that the primary barrier to securitizing RLF loans 
stemmed from the fact the lenders did not want to sell their loans. 
[Footnote 35] According to key officials knowledgeable about one of the 
four demonstration projects, lenders did not find the deal attractive 
because they had access to cheaper capital through the EDA grant 
program. Additionally, lenders would not commit loans for sale into the 
loan pool in advance because they were unsure whether good borrowers 
would be available to whom they could relend the sale proceeds. Also, 
the Department of Commerce's Office of Inspector General recently found 
that some RLFs funded by EDA were carrying excessive capital reserves 
and required them to return these funds to the program, and that EDA 
monitor the RLF to ensure continued compliance. These lenders would not 
need the liquidity benefits from securitizing their loans. According to 
program officials in ARC, lenders funded by ARC do not wish to 
securitize their loans and are now prohibited from doing so. Officials 
explained that there were a number of reasons why ARC grantees did not 
want to securitize including loss of interest on loans they hold; 
limited yields accrued from securitizing their loans; and limited need 
for liquidity given readily available grant funding they receive 
through the ARC program. Preliminary results from the Department of 
Treasury's secondary market feasibility study indicates that while 
about one-third of the respondents have sold at least some loans they 
originated, CDFI participation in the secondary market for loans 
remains small. Many of the markets have not traditionally worked with 
CDFIs because of the small typical size of the CDFI loans, their 
nonstandardized loan portfolios, and concerns about the lenders' 
ability to meet loan-servicing requirements. About 23 percent of the 
respondents reported not knowing enough about the secondary market to 
participate. USDA piloted an effort to securitize IRP loans in 1998 
but, according to program officials, it failed because the requirements 
for participation were too restrictive for most of the lenders to meet. 
For example, lenders who could not demonstrate an ability to repay the 
entire principal balance on their loan to USDA were ineligible to 
participate in any sale of the assets from their portfolios. HUD's 
Section 108 loan guarantee program, one of our five existing 
securitization models, is proposed for elimination in fiscal year 2004, 
according to the Office of Management and Budget.[Footnote 36] A recent 
HUD study cited the program's collateral requirements and lengthy 
approval process as the two major reasons for declining program 
usage.[Footnote 37] Senior HUD program officials cited the elimination 
of the Economic Development Initiative (EDI) program as the principal 
reason for the decline in use of the Section 108 program in fiscal year 
2001. Although the volume of lending has increased since that time, it 
has not returned to the pre-2001 loan volume level.

We identified other reasons for the lack of lender interest in the 
securitization efforts described above. First, the benefits of 
securitization are not always clear to lenders. Second, as indicated 
earlier, some of the lenders depend on income streams generated by 
their portfolios, making it difficult for some of them to sell portions 
of their portfolios. CED lenders that do not diversify their portfolios 
are particularly vulnerable to interruptions in the stream of income 
coming from a smaller pool of loans. During favorable economic times, 
the market in which CED lenders operate is pressured by competition 
from conventional lenders, thereby diminishing the demand for CED 
loans. While a number of securitization efforts have been undertaken, 
given uncertain borrower demand for CED loans and limited lender 
interest in securitizing loans, it is uncertain what volume of CED 
loans might be available for securitization on a wide scale. Without 
greater certainty, capital market participants do not have a reason to 
invest in developing a market for securitizing CED loans.

Insufficient Capacity Limits Lenders' Ability to Participate in 
Securitization:

Limited lender capacity--constrained by factors such as reliance on 
small portfolios, insufficient financial information, and an 
insufficient number of staff or inadequate staff skills--limits some 
lenders from being able to participate in securitization. Many CED 
lenders' portfolios contain only or mostly small loans. For instance, 
the average loan size for microlenders is $11,600. In addition, lenders 
work extensively with their borrowers to help them qualify for loans. 
This requires more time than required to make conventional loans and is 
often necessary to ensure borrower success. Although lenders operate 
this way to meet their mission, one study indicates it results in 
higher per loan costs, which in turn can increase the subsidy required 
on each loan financed.

According to studies, lender trade associations, and private-sector 
officials, lenders do not have sufficient financial information to 
determine how much of a discount they could absorb. To ensure that an 
asset an investor purchases provides market yields, capital market 
participants require lenders to sell loans at a discount to at least 
cover the additional risk--including interest rate risks and credit 
risks--they might incur from securitizing loans. Lenders might benefit 
from securitization if they could sell their loans at a price that best 
met their current financial needs. However, according to trade and 
program officials, some lenders do not have adequate financial 
information to determine whether a given price is or is not in their 
best interest, given the discount they would have to absorb in the 
sale. For instance, some may not know how much it was costing them to 
originate and service these loans and the income they could expect to 
earn from these loans. With better information, lenders would be better 
able to determine whether the discount being requested was appropriate 
and beneficial, given their knowledge of the performance and value of 
the loans in their portfolios.

In addition, studies and lender trade associations indicate lenders 
lack sufficient staff and staff with appropriate skills to manage the 
increased activity they believe securitization would create. According 
to a Ford Foundation study on CDFIs, many of these CED lenders offer 
salaries and benefits that are significantly lower than those attached 
to jobs with similar responsibilities and scope in the private 
sector.[Footnote 38] As a result, these lenders may have a hard time 
competing for highly qualified and desirable candidates. Further, 
lender trade associations with whom we spoke noted that many CED 
lenders lack staff with the expertise to manage the increased workload 
lenders might incur from portfolio sales. In addition, some CED lenders 
experience difficulty originating and servicing loans, including 
working out impaired loans, in a timely manner because staff lack 
expertise and experience. The uncertainty about lender experience is 
factored into the discounts charged by the markets. The Ford Foundation 
study notes that while these impediments tend to be true across a range 
of CDFI lenders, the extent of these impediments vary by lender. For 
example, many of the larger loan funds have been able to increase 
salaries enough to have significant success in attracting staff from 
banks and other financial institutions, while the smaller loan funds 
have had much less success in doing so.

External Requirements May Prevent or Serve as a Disincentive for 
Securitization:

Lenders receive funds from various sources and must comply with the 
various requirements or laws governing how the funds must be spent. 
These requirements may negatively impact CED lenders' ability to sell 
their loans to third parties, ultimately preventing securitization. The 
impact could be direct or indirect. For example, some CED lenders 
receive funds from more than one federal source and often underwrite 
loans to different specifications, as determined by the various federal 
regulations governing the funds. Disparate external requirements 
indirectly impact securitization because they serve as a disincentive 
for CED lenders to develop standard underwriting procedures, thus 
increasing the difficulty and costliness of structuring a 
securitization.

Several federal programs offer illustrations of how lending 
requirements may inhibit securitization. Some CED lenders reject the 
idea of securitizing loans made with federal funds because some federal 
programs, such as EDA, require that lenders use the proceeds on the 
sale of a loan to make subsequent loans with the same purpose. For 
example, an EDA RLF selling a disaster assistance loan would have to 
use the proceeds on that loan sale to make additional loans for 
disaster assistance. In addition, lenders in HUD's CDBG program that 
wish to sell their loans must ensure that the buyer will uphold 
requirements to meet HUD national objectives.[Footnote 39] Some 
requirements have a direct impact on lenders' participation in 
securitization. For example, ARC prohibits CED lenders in its program 
from selling the loans they make with ARC funds.

Lenders Believe Below-Market-Rate Products Will Not Meet Market 
Requirements without Substantial Discounts:

CED lenders' missions, along with the purpose behind the supporting 
federal programs largely dictate the loan products and services lenders 
offer. As such, CED lenders generally offer below-market interest rates 
or other flexible, nonconforming loan terms to small businesses that 
are generally unable to obtain reasonable credit terms from traditional 
lending institutions. Capital markets require discounts when 
securitizing below-market-rate loans so that the effort will result in 
investments with market yields, cover transaction costs associated with 
securitization, and offset the uncertain performance of the underlying 
asset. To cover potential credit concerns, capital markets may also 
require that lenders provide a credit enhancement to offset the 
uncertainty of loan performance. Some lenders believe that the discount 
or credit enhancement that investors would require for securitizing 
their loans would be too great. Some report that capital market 
investors would require higher discounts than they would for 
securitizing other assets because CED loans are not well understood. On 
the other hand, some federal program officials fear that should 
securitization become an option for CED lenders to obtain additional 
capital, lenders would shirk their mission in favor of lending to more 
conventional borrowers.

Even if lenders were only required to accept a discount to offset the 
below-market interest rate, they have a disincentive to sell their 
loans. When holding loans, lenders account for the value of loans by 
using the unpaid principal balance, less any allowance for loss--called 
net book value. However, if a lender were to sell a loan, it would have 
to recognize as a loss the difference between the sales price and net 
book value. When purchasing below-market-rate loans, investors would 
require a sales price below the unpaid principal balance to obtain a 
market yield--requiring lenders to recognize a loss and creating a 
disincentive to sell loans. In effect, selling loans would require a 
lender to recognize the market value, rather than the higher book value 
of their loans.

Lack of Standardization and Inadequate Performance Information Inhibit 
Securitization:

CED lenders currently operate independently of each other, resulting in 
nonstandard loan underwriting, documentation, and servicing. CED 
lenders also lack an infrastructure for consistently recording the 
performance of lenders and loans. As mentioned previously, the sources 
of capital and the missions of CED lenders encourage CED lenders to 
underwrite and service loans tailored to meet the unique needs of 
borrowers in their communities. CED lenders also use varying 
definitions and documents and utilize differing servicing policies. 
Additionally, CED lenders have difficulty providing sufficient and 
consistent performance information in a useable way. For example, few 
lender groups have a facility for aggregating current loan-level 
performance information across lenders. Lender reporting may or may not 
be automated, and the performance data reported are not defined 
consistently across lenders.

Investors in securitized financial assets generally require reliable 
assurances that the securities will pay interest and principal fully 
and in a timely manner despite the performance of the overall economy. 
Credit ratings from agencies such as Moody's or Standard & Poor's can 
often provide these assurances. Additionally, securitizations require a 
credit rating in order to be considered "investment-grade" and 
attractive to institutional investors.[Footnote 40] Credit ratings play 
an important role in determining how the securities should be 
structured and priced to appeal to investors, including feedback on any 
levels of credit enhancement that may be necessary to achieve a desired 
structure. Securities raters examine certain characteristics of 
proposed securitizations in order to provide their assessment of the 
performance of a pool of assets and ultimately their credit rating as 
follows:

* Rating agencies examine current and historical loan and lender 
performance data such as delinquencies, defaults, and losses to assess 
the expected performance of a pool of similar loans over time.

* Rating agencies examine originator and servicer characteristics such 
as management and financial strength, servicing and collection 
practices, back-up servicing, workout and liquidation policies, and 
data processing and reporting to assess originators' and servicers' 
capability to execute their functions adequately and in a timely 
manner.

* Rating agencies examine the legal structure of the transaction to, 
for example, assure investors that the pooled assets have been properly 
sold to the bankruptcy-remote vehicle.

Generally, the larger the number of similar loans included in a loan 
pool (that is, loans with more homogeneous loan underwriting, 
documentation, and servicing) the less costly securing a rating can 
be.[Footnote 41] Additionally, better and consistent data can reduce 
the costs of securing a rating and allow for more precise estimates of 
performance, also providing for accurate assessments of any required 
internal credit enhancements.[Footnote 42] The variety of CED lender 
practices and inadequate performance information prevent or inhibit 
capital markets from satisfactorily understanding the performance of 
CED loans and increase the transaction costs involved with assessing 
performance. The benefits of securitization are greatly reduced for CED 
lenders to the extent they must fund any extra transaction costs for 
these services, as well as fund credit enhancements to cover unexpected 
losses that capital markets cannot satisfactorily profile. Proposals to 
reduce these costs through standardization are viewed by many CED 
lenders as contrary to their missions.

Limited Mechanisms Available to Support Securitization for CED Loans:

According to trade association representatives and other interest 
groups, if securitization is to become a viable alternative for 
lenders, information-sharing and securitization mechanisms are needed 
to provide consistent avenues for lenders to sell their loans, achieve 
the volume of loans needed for a securitization, and achieve quality 
control. That is, lenders have no apparent and available network or 
facility from which to draw if and when selling loans. Likewise, 
investors have no apparent facility or entity from which to purchase 
securities backed by CED loans. In contrast to other mortgage-backed 
and asset-backed securitizations, there is no comprehensive mechanism 
for sharing information with interested lenders, investors, and capital 
market intermediaries. Ad hoc networks, lender trade associations, and 
investor organizations do exist, but they do not provide updated and 
comprehensive data and information on a regular basis regarding loan 
volume. Neither do they provide a list of interested lenders, potential 
investors, securitization mechanisms, and credit enhancement 
providers.

Existing securitization mechanisms are limited in two different ways. 
First, there are few mechanisms available to securitize small business 
and CED loans. Second, some of those that do exist have limitations. As 
noted earlier, we could only find five existing models that securitize 
small business or CED loans and three of them use 100-percent federal 
credit enhancements. CRF is the only existing securitization mechanism 
that actually purchases and securitizes CED loans without direct 
federal government support. However, as we also noted earlier, CRF has 
several important limitations. It is the only securitizer to provide a 
credit enhancement and, as a nonprofit entity, depends on the 
availability of foundation and other philanthropic sources to fund its 
credit enhancements. Since CRF's securities depend on private 
placements and do not have credit ratings, the number of investors, 
particularly institutional investors, that are able to purchase its 
senior tranche securities is greatly limited too. The Section 108 model 
is limited by its collateral requirements and the lengthy time needed 
for HUD's approval of each loan, according to a recent Urban Institute 
study. The study also found that collateral requirements may have 
particular force in cases where Section 108 is used to capitalize small 
business lending programs and where borrowers may have little security 
to offer. In addition, since 2001, with the elimination of funding for 
the EDI grant program, grantees can no longer use EDI funds to satisfy, 
in part, collateral requirements. Finally, the administration is 
proposing to eliminate Section 108. Taken together, the limited extent 
of information sharing and the limitations of securitization mechanisms 
inhibit the CED lending industry's willingness and ability to 
efficiently sell their loans on a large scale.

Potential Options Exist to Overcome Barriers, but Most Imply Costs or 
Changes to Federal Programs:

CED lenders, their organizations, some federal agencies, and others 
have identified options the federal government could employ to 
potentially overcome securitization barriers. Generally, these options 
involve either providing incentives or requiring or providing direct or 
indirect support to resolve identified barriers. However, implementing 
these options singly or in combination would have ramifications--both 
positive and negative--for federal programs and the clientele served by 
these programs. For instance, some options could require additional 
resources, while others could cause lenders to focus less on CED 
lending. Some options could directly resolve or address the barrier, 
while still others could improve program or lender management. 
Furthermore, the options for overcoming the barriers often entail 
federal costs. However, we did not determine whether the benefits 
exceed the costs that could result from such efforts and, therefore, do 
not endorse these options.

Potential Options for Overcoming Uncertain Borrower Demand and Limited 
Lender Incentives for Securitization and Their Implications:

As discussed previously, uncertain borrower demand and limited lender 
incentives for securitization could result in unpredictable or 
insufficient loan volume necessary for securitization to work 
efficiently. We have identified options that could help to better 
define and measure borrower demand across markets and promote lender 
understanding of borrower demand and the cost and benefits of 
securitization. We also identified options for providing incentives to 
lenders to make loans available for securitization. Ultimately, 
however, the market will largely determine what the underlying demand 
for CED loans will be.

Overcoming Uncertain Borrower Demand Might Begin with Measuring Demand:

Some of the specific options for addressing uncertain borrower demand 
involve requiring or supporting research into how to measure borrower 
demand, helping develop and ensure application of consistent 
definitions and measures for periodically measuring borrower demand 
across lenders and programs, and aggregating this information. These 
actions could promote increased understanding of borrower demand and 
may have the added benefit of improved lender and program management--
provided procedures and definitions are clearly defined and 
implemented, and that measures are taken systematically and frequently 
to track ever-changing markets. However, it is unclear whether 
increased understanding of borrower demand, alone, would motivate 
lenders to participate in securitization. In addition, as with any data 
collection effort of this magnitude, it would likely be costly and 
time-consuming to put a system in place. Therefore, it may be necessary 
to preface any efforts with a cost-benefit analysis.

The federal government could promote lender understanding of borrower 
demand through the use of forecasting tools, either across target 
markets or as part of programs. Provided these tools were defined, 
applied, and aggregated consistently, they could provide greater 
understanding of future borrower demand across target markets. Again, 
given the potential costs, a cost-benefit analysis might be warranted 
before pursuing such an effort.

The federal government could require or support efforts to increase 
information exchange among lenders. For instance, incentives could be 
implemented for CED lenders and local banks to refer potential clients 
to one another. This option could help lenders gain access to better 
borrower demand information in their local markets. Another option, a 
peer-to-peer system, could inform CED lenders of potential loans 
available outside their traditional markets. This process could help 
CED lenders anticipate changes in borrower demand across target 
markets, perhaps nationwide. The costs of implementing either of these 
options are not well known. Without a mandate, marketing tools may be 
necessary to promote the use of either of these options. Either of 
these options could help to make more transparent the demand for CED 
loans, provided this sort of exchanged information could be aggregated 
and analyzed in a useful way.

Federal Government Could Potentially Improve Lender Understanding of 
Securitization and Create Lender Incentives for Securitization:

As we discussed earlier in this report, while some lenders do 
securitize their loans, others lenders with securitizable loans could 
realize, but do not perceive, the benefits to securitization. These 
lenders, for example, may have existing low-cost sources of capital and 
rely on interest income to support their operations and would have 
difficulty sustaining expanded lending operations that securitization 
would allow. We identified options for identifying those lenders that 
might benefit from securitization, informing those lenders about 
securitization and its benefits, and building incentives for lenders to 
securitize their loans.

The federal government could help identify lenders that could benefit 
from or are ready for securitization by financing or supporting the 
development of a study designed to establish criteria, procedures, and 
practices for identifying such lenders, or requiring that such 
procedures be implemented. However, defining and identifying lenders 
that could benefit from securitization might not directly cause these 
lenders to consider securitization. To do so, the federal government 
could also promote better understanding of the benefits to lenders of 
securitization so that those lenders that were able and would benefit 
from securitization would use securitization as a means to expand 
community and economic development lending. Such efforts would require 
costs to the federal government.

To provide greater encouragement, the federal government could also 
provide direct incentives for lenders to securitize their loans. For 
example, the government could build incentives for lenders (such as 
program set-asides, awards, or requirements) into existing federal 
programs. While built-in program incentives could have a direct impact 
on lenders' willingness to securitize their loans, the impact on 
lenders' missions could vary depending on how support for these 
incentives is provided. For instance, unless additional funding was 
awarded specifically for such incentives, providing incentives through 
program set-asides, or program awards application processes, might give 
qualified lenders the ability to securitize, but decrease, the amount 
of available funding for all other lenders awarded grants or loans 
decreasing the federal support to meet their missions.

Requiring lenders to use existing program dollars allocated to them for 
securitization would not impact other lenders. However, if all lenders 
with qualifying loans were required to use program dollars for 
securitization, fewer dollars might go toward borrowers in the short-
term until those lenders gained access to capital from the sale of 
those loans. On the other hand, the government could also eliminate 
disincentives to selling loans by, for example, reducing the use of 
grant funds. Again, such an option would have an immediate impact on 
lender behavior but also potentially motivate lenders toward less risky 
lending.

Potential Options Exist to Overcome Limited Capacity, but Each Has 
Implications:

Limited lender capacity is an underlying reason why lenders lack 
incentives to participate in securitization. To help lenders access or 
analyze information on whether securitization would be useful, and to 
manage increased workload they would incur if they were to securitize 
their loans, some lenders need to improve their staff skills and 
financial information capabilities. Additionally, lenders' long-term 
viability could be enhanced through greater diversification of their 
portfolios.

Options the federal government could exercise include providing, 
requiring, or supporting training and technical assistance to: (1) 
increase skill levels of lenders in order to reduce the staff time 
spent on loans, (2) improve financial and accounting information needed 
to make decisions on whether benefits outweigh the costs of 
securitization, and (3) inform lenders of the benefits of diversifying 
their portfolios. Possible options also include supporting an increase 
in the number of lender staff needed to manage any potential increases 
in workload they might incur by securitizing their loans.

These options could not only move the industry closer to securitization 
by improving lender knowledge and capacity needed to securitize their 
loans, but could also have the added benefit of increasing lender 
capability and, thus, more prudent use of federal program dollars. 
However, each of these options also has other implications. For 
instance:

* Exercising options such as training and information sessions designed 
to inform lenders of the benefits of diversifying their portfolios 
could result in lenders investing in either larger loans or more 
collateralized assets. However, altering lender portfolios in this way 
could result in lenders making loans to less risky borrowers, moving 
them slightly "up-market" (that is, to more creditworthy borrowers) and 
thus further away from their mission. On the other hand, diversifying 
their portfolios with more of a balance of larger and smaller loans and 
loans of varying risks could help lenders' long-term viability.

* Exercising options to increase staff skill levels through training or 
providing tools to increase staff skills, improving financial and 
accounting information, and for increasing the number of staff will 
have added costs. Costs to the federal government will vary depending 
on whether the government takes a direct or supportive role in 
developing and implementing training courses or information sessions or 
funding increased staff or tools for these lenders. However, improved 
lender management and technical skills could increase lender 
efficiency.

* To ensure the effective use of limited federal resources, any support 
for training, technical assistance, or staffing would require 
appropriate federal oversight and evaluation.

Options Exist to Overcome Restrictive External Requirements, but Each 
Has Implications:

Our research identified a number of requirements that either directly 
or indirectly limit lenders' ability to participate in securitization. 
To allow lenders the ability to pool and sell loans, these requirements 
and others like them, would need to be identified and either modified 
or removed.

The federal government could exercise several options for identifying 
and modifying or removing restrictive requirements, including requiring 
programs to work collaboratively to identify and resolve conflicting 
regulatory requirements that prohibit or inhibit securitization and 
develop proposals for resolving conflicting statutory requirements. 
While these options have the potential to expand the number of lenders 
that may consider securitizing CED loans, each option has other 
implications such as the following:

* Identification of conflicting federal, state, local, and private 
requirements governing how CED funds must be spent could be costly and 
time consuming because of the need to coordinate efforts on several 
levels.

* Removing some requirements may impact lenders' ability to meet the 
mission of the federal programs that support them. For example, if 
requirements that lenders use loan sale proceeds to make loans with the 
same purpose are eliminated, EDA has no assurance that the lenders it 
supports would continue to meet program goals and objectives. Before 
removing such restrictions, their purpose and rationale should be 
weighed against the benefits of securitization.

Options Exist to Potentially Overcome Impact of Below-Market-rate Loans 
on Securitization, but Each Has Implications:

Some studies we reviewed, and lenders with whom we spoke, cite the very 
nature of CED loans as a barrier to securitization because these loans 
often have below-market-rates. Discounts on below-market-rate loans are 
a consequence of the need to provide market yields on investments and 
to cover the transaction costs associated with carrying out any 
securitization. Securitization of CED loans may also require discounts 
to offset any additional transaction costs due to the lack of 
performance information and nonstandard loan underwriting. Loans made 
with limited collateral, and with riskier borrowers, will continue to 
need either some type of subsidized financing, such as the below-
market-rate loans provided by these lenders, or other mechanisms such 
as offering longer loan terms that allow borrowers to make lower 
monthly payments.

The federal government could exercise several options to enhance 
lenders' abilities to securitize below-market-rate loans. The federal 
government could provide a direct subsidy or incentives for others to 
provide support to lenders to offset the discount charged to lenders 
for securitizing below-market-rate loans. The implementation of any one 
or all of the options discussed in other parts of this section (from 
measuring borrower demand to improving loan performance information) 
would diminish lender costs and diminish, in part, the need for lender 
discounts. However, as explained in those sections, these options have 
other implications as well. Provision of a direct federal subsidy or 
incentives for others to provide support would result in federal costs.

Options Exist to Overcome Lack of Standardization and Insufficient 
Performance Information, but Each Has Implications:

The level of heterogeneity among community lenders and loans, and the 
lack of adequate performance information regarding these lenders and 
loans, results in disincentives to securitize. Capital markets cannot 
sufficiently, or cost-effectively assess the expected performance of a 
heterogeneous pool of loans and, thus, cannot accurately assure 
investors of the creditworthiness of a pool of CED loans. The benefits 
of securitization are greatly reduced for community lenders as they 
fund any extra transaction costs for these services and credit 
enhancements to cover unexpected losses that capital markets cannot 
adequately profile.

Developing a Level of Standardization Would Involve Supporting Data and 
Underwriting Standardization:

The federal government could provide incentives (such as set-asides or 
awards) for federal programs and/or capital markets (or other financial 
institutions that securitize similar loans, such as commercial banks) 
to collaborate in order to develop standardized performance 
information, loan documentation, servicing, and underwriting criteria 
and procedures that are useable for both capital markets and CED 
lenders. Developing new criteria and procedures through this type of 
collaboration might improve CED lenders' ability to securitize or to 
develop innovative financing arrangements other than securitization. 
Given the varied and diverse nature of community lenders nationwide, 
providing outreach and education on any information or procedural 
standardization could also facilitate the timely implementation of any 
new criteria or procedures.

Developing and applying homogeneous loan and lender performance 
information--key performance data points, definitions underlying those 
data points, frequency for reporting data, and preferred format for 
collecting the data for CED lenders--has several implications. The 
earlier performance information could be developed and collected from 
CED lenders, the sooner CED lenders could communicate a useable 
performance profile to financial institutions and thus help to improve 
their overall effectiveness as CED lenders. Aggregating and maintaining 
performance information in a central facility--a "data-warehouse"--
accessible by CED lenders, loan pool assemblers, and federal programs, 
may provide: (1) community lenders an easier way to report and monitor 
their performance, thereby reducing any administrative burdens 
accompanying repetitive federal reporting requirements; (2) loan pool 
assemblers and rating agencies more cost-effective means to assess and 
profile the risk of differing types of CED loans, helping to diminish 
the securitization transaction costs lenders currently fund; and (3) 
federal programs and Congress better data to make key programmatic 
decisions within and across programs. Federal support for efforts to 
develop and apply homogeneous loan and lender performance information 
would result in costs to the federal government, but it may improve 
program management in the long-term. Deciding where to develop, store, 
and manage this data should take in account, privacy, access, and 
Freedom of Information Act issues.

Developing homogeneous loan underwriting, servicing, and documentation 
standards would likely require a balance between the level of 
standardization necessary for cost-effective, reliable performance 
estimates and a sufficient level of flexibility for CED lenders to meet 
the needs of their communities. The tighter the standards, the less 
likely CED lenders would be able to tailor their services to their 
communities, thus potentially diminishing the effectiveness and 
benefits of CED lenders to communities. Conversely, the looser the 
standards, the more costly assessing the performance of CED loans 
becomes, thus diminishing the benefits of securitization as a funding 
source for CED lenders. Developing a range of underwriting and 
servicing standards for a variety of loan products would limit lender 
flexibility for a particular loan product, but these standards may be 
designed to accommodate the mission of community lenders. Additionally, 
with enough available loan and lender information, a range of standards 
may allow a pool assembler to assemble a reasonably homogeneous pool of 
similar loans from a nationwide pool of mission-oriented CED lender 
portfolios. Developing standards for underwriting, servicing, and 
documentation can require substantial effort. To the extent that these 
efforts are funded through federal programs, or through incentives 
provided lenders and others, these efforts may impose federal costs.

Credit Scoring Could Diminish Need for Other Information:

The federal government and CED lenders could examine the use of credit 
scoring as an indicator, for example, of the likelihood of borrower 
repayment of principal and interest. Some commercial banks now consider 
credit scores primary criteria for underwriting small business credit 
decisions. Several studies and interviews have indicated that credit 
scoring is a technique with the potential to reduce the need for 
standardized underwriting procedures. Using credit scores to estimate 
the likely performance of a pool of loans based upon borrowers with 
similar creditworthiness might be more cost-effective than estimating 
the performance of a pool of heterogeneous loans. If credit scores 
produce performance probability estimates reliable enough for rating 
agencies, investors and lenders can more accurately assess their 
financial incentives and disincentives to securitize CED loans. 
Additionally, credit scores may reduce the cost of loan origination. 
Whether credit scoring loans will affect the missions of CED lenders is 
somewhat dependent on the lender. Credit scoring may allow CED lenders 
to underwrite loans tailored to their target markets and sell 
occasional loans to pools accepting certain credit score ranges. Or, 
some CED lenders might only originate loans with credit scores 
acceptable for resale into pools accepting certain credit score ranges, 
thereby limiting the types of lending they would do in their 
communities. Credit scoring might limit borrowers with little or no 
credit history from accessing CED financings. Finally, questions still 
exist as to whether credit scoring disadvantages minority or other 
segments of the population.

Use of Governmental Credit Enhancements Could Minimize the Need for 
Other Loan Performance Data:

Governmental credit enhancements could be applied in a number of ways, 
but could result in increased costs to the federal government. However, 
the level of the credit enhancement would determine the extent to which 
standardization and performance data would be needed. A security issued 
with a 100-percent federal credit enhancement could minimize the need 
for standardization and loan performance data because it is backed by 
the full faith and credit of the federal government and, therefore, 
would not need to obtain an independent credit rating. However, such a 
federal credit enhancement could expose the federal government to 
potentially greater risk and cost and would also require a minimum 
degree of standardization and review, depending upon the capabilities 
and loan performance record of the lender. For example, in FHA's 
Multifamily Insurance Risk-Sharing Program, state and local housing 
finance agencies receive a 100-percent federal credit enhancement, and 
the most experienced lenders are allowed to use their own underwriting 
standards and documents in return for assuming 50-90 percent of the 
credit risk. Compared with a 100 percent credit enhancement, a partial 
federal credit enhancement reduces the government's risks and potential 
costs, but generally subjects the loans to be securitized to an 
evaluation by the credit rating agencies or investors (for unrated 
securities). Such an evaluation would necessarily include the 
standardization and loan performance issues discussed earlier. Whether 
a 100 percent or a partial federal credit enhancement, federal agencies 
will need sufficient loan performance data to estimate the credit 
subsidy cost of the credit enhancement. Given the possible increased 
cost and risk the government incurs, credit enhancements should be 
minimized and their continuing need be assessed periodically. Such 
assessments would require criteria for determining the continued need 
for credit enhancement.

Options Exist to Potentially Overcome Limited Mechanisms for 
Securitizing, but Each Has Cost and Other Implications:

Lack of or limits in information sharing and securitization mechanisms 
are seen by many as a barrier to securitization. Currently, there is no 
comprehensive mechanism for lenders, investors, and capital market 
intermediaries to share information on loan volume with interested loan 
buyers and sellers. There are also few mechanisms available to 
securitize small business and CED loans, and there are limitations with 
some of the existing mechanisms. We have identified several options for 
creating a consistent mechanism for securitizing CED loans. These 
options are as follows:

* The federal government could help establish formal networks for 
lenders and capital market participants to exchange information on 
loans available for sale and for interested loan purchasers to provide 
specialized origination and loan sale functions. Examples of networks 
could include a formalized group of lenders, investors, and capital 
market intermediaries or super-regional CED lenders who would be part 
of a voluntary regional network of local CED lenders. For the networks 
to be effective, they would need to provide tangible benefits to both 
lenders and capital market participants. For example, super-regional 
lenders could specialize in originating and selling larger, long-term 
loans referred to them by retail lenders, who could participate in the 
underwriting and loan servicing responsibilities and share in the loan 
fees. This may also allow local lenders more time to concentrate on 
smaller, short-term loans to be held in their portfolios. Implementing 
the networks may also require different degrees of federal funding.

* Two existing securitization mechanisms that could serve as a basis 
for greater securitization of CED loans are CRF and the Section 108 
guaranteed security programs. However, these structures have certain 
limitations that would first need to be addressed. CRF depends on the 
availability of foundation and other philanthropic sources to fund its 
credit enhancements, thereby limiting its capacity to sell more 
securitized loans to investors. Since CRF's securities have only been 
privately placed and do not have credit ratings, the number of 
investors, particularly institutional investors, who are able to 
purchase its senior tranche securities is limited. Increasing CRF's 
capacity to securitize more loans and providing it with a large enough 
credit enhancement would allow CRF to obtain a credit rating. 
Addressing CRF limitations could include providing direct federal 
funding for partial credit enhancements or match funding to attract 
other funding sources such as state and local government and program-
related investors, as well as assistance in developing standardized 
loan products. However, providing partial federal credit enhancements 
could have both positive and negative effects depending upon the credit 
risks associated with the lenders and loans included in each loan pool 
to be securitized. Such credit enhancements would likely impose costs 
on the federal government. In addition, these options may have a 
negative impact on lender mission if standardization reduces lender 
flexibility to the point that loan terms no longer meet borrower needs 
or excludes targeted borrowers. However, lenders may be able to target 
greater resources to serving targeted markets if they can offer new 
loan products such as, long-term, fixed-rate real estate loans. In 
addition, the Urban Institute study found that the average loan size of 
Section 108 loans to third parties was about $1.5 million.[Footnote 43] 
Thus, the model securitizes much larger loans than many of those 
financed by many lenders covered in our review. For example, the 
average loan size for CDFIs is $66,000 for business loans and $11,600 
for microenterprise loans. Finally, as indicated previously, the 
administration is proposing elimination of the Section 108 program. If 
the program remains or the model is adopted elsewhere, the model's 
current limitations could be addressed. For example, the government 
could address the collateral concerns, particularly by communities that 
capitalize loan funds, while taking into account risks borne by the 
federal government. The government could also assess why the Section 
108 model is not used more widely to securitize CED loan funds. This 
would require a better understanding of the extent to which Section 108 
loan guarantees are used as a funding source for loan funds. Such 
efforts would involve costs for the federal government, but could lead 
to improvements in the program's and the securitization mechanism's 
usage.[Footnote 44]

* The government could also opt to create new securitization mechanisms 
ranging from those with little or no credit enhancements to options 
with full credit enhancements. These structures could be supported by 
different entities such as the federal government or the private 
sector. For example, the government could create a new mechanism 
similar to the CDA securitization model with a partial federal credit 
enhancement. Another option might be a demonstration program with a 
100-percent federal credit enhancement of the security plus sharing the 
credit risk of the underlying loans in a manner similar to the FHA 
Multifamily Risk-Sharing Program described earlier. For instance, if 
the risk-sharing demonstration with a 100-percent federal enhancement 
of the security were limited to CED lenders with high performing 
portfolios and high loan volume, standardization requirements would be 
minimized, thereby reducing lender mission impact. But this sort of 
federal credit enhancement might have negative cost consequences for 
the federal government, depending on the effectiveness of the risk-
sharing mechanisms adopted and the quality of the lenders and loans 
included in the program. The implications for the proposed CDA model 
are less known since there are no current securitization models that 
use partial federal credit enhancements to securitize any loans. Since 
CDA proposes to purchase only seasoned loans and update their 
borrowers' credit scores, the need for standardization may be minimized 
because credit rating agencies would know the loans' short-term 
financial performance and their borrowers' current creditworthiness. 
Since the rating agencies would still not have the long-term loan 
performance data they need to statistically predict loan delinquencies 
and defaults, they would adjust the amount of credit enhancement 
upward, but by a smaller amount than required for pools of new loans 
with outdated credit scores. Overall, any options for providing 
enhancements to create additional mechanisms for securitization will 
require administrative effort and federal costs.

* The government could also build upon existing structures that 
securitize non-CED loans by providing incentives for private sector 
entities to securitize CED loans. However, private sector 
securitization entities may not agree to securitize CED loans or may 
"demand" too high a cost to the federal government. In addition, 
because private securitization mechanisms require standardized 
underwriting, lenders' mission may be negatively impacted. However, the 
impact standardization might have on lender mission could be mitigated 
if securitization could provide CED lenders with new kinds of loan 
products that they generally do not now originate, that is, larger, 
long-term, fixed-rate loans. Overall, providing incentives to private 
sector entities to securitize CED loans would require federal costs. To 
ensure the effective use of federal resources, any such program or 
incentives would also require appropriate federal oversight and 
evaluation.

Observations:

Given the importance of volume in achieving efficiencies that could 
help securitization work effectively, uncertain borrower demand and 
limited lender incentives are critical barriers that would need to be 
addressed if CED loans are to be securitized widely. Therefore, 
securitization may not be a significant alternative for these lenders 
until the volume of loans available for securitization is known 
industrywide, and lenders are convinced of its benefits enough to 
participate. Further, limited lender management capacity, prohibitive 
external legal or regulatory limitations and requirements, and 
discounts due to below-market-rate financing are barriers consequent to 
the nature of CED lending. For varying reasons discussed in detail 
above, these barriers also combine to explain the lack of lender 
incentives to securitize their loans. Therefore, these barriers, along 
with the cost associated with their elimination, are factors to be 
addressed if CED loans are to be securitized widely. In addition, 
eliminating these barriers entail costs.

The remaining barriers--lender heterogeneity, insufficient performance 
information, and limited mechanisms for securitizing loans--are 
traditional barriers that have been experienced to some degree in the 
development of other securitization models. Some of the actions we 
outline, such as developing homogeneous documentation and performance 
information, may help to improve lenders' overall effectiveness in 
dealing with local and national capital markets in a range of financing 
transactions, including securitization, and could help improve program 
management. However, the costs and benefits of these actions should be 
assessed before they could be considered viable. Developing homogeneous 
underwriting and servicing policies requires recognition of the tension 
between the flexible underwriting these lenders employ to serve their 
communities versus the standardization needed to cost-effectively 
securitize loans. Additionally, any mechanisms developed to further CED 
loan securitizations will not succeed without visible financial 
benefits for lenders and capital market participants.

In addition, some of the options we have identified to improve lender 
management practices, data on lenders and loans, and consistency in 
assessing and documenting loans could not only move the industry closer 
toward securitization, but could have the added benefit of improved 
management and oversight for lenders and the federal programs that 
support them. However, their costs and benefits need to be assessed. If 
cost/benefit analyses prove them to be cost-effective, these are steps 
that could help the industry regardless of whether securitization 
becomes a viable option.: 

While the options we identify have many likely implications, we did not 
measure the extent to which each may affect lenders' mission, federal 
costs, program oversight, and other potential implications. Likewise, 
we did not determine whether the potential benefits exceed the costs 
that could result from such efforts. We, therefore, do not endorse 
these options. Nonetheless, the information we present provides a 
framework for understanding the challenges when considering the federal 
role in facilitating securitization.

Agency Comments and Our Evaluation:

Officials in all agencies provided technical comments that we 
incorporated into the report, where appropriate. The technical comments 
from HHS were from officials in HHS's Administration for Children and 
Families. Generally, the agencies did not indicate whether they agreed 
or disagreed with the report's findings.

:

We are sending copies of this report to interested congressional 
parties and to the Secretaries of Agriculture, Commerce, Health and 
Human Services, Housing and Urban Development, and Treasury, the SBA 
Administrator, and the Federal Co-Chair of the Appalachian Regional 
Commission. Copies will be made available to others upon request. In 
addition, the report will be available at no charge on the GAO Web site 
at [Hyperlink, http://www.gao.gov] http://www.gao.gov.

Signed by:

Please contact Mathew J. Scirč, Assistant Director, or me at (202) 512-
8678, or by e-mail ( [Hyperlink, sciremj@gao.gov] sciremj@gao.gov or 
[Hyperlink, shearw@gao.gov] shearw@gao.gov ) if you or your staff have 
any questions concerning the report. Key contributors to this report 
were Diane T. Brooks, Tiffani L. Green, Mitchell B. Rachlis, Barbara M. 
Roesmann, Keith A. Slade, and James D. Vitarello.

William B. Shear 
Director, Financial Markets and Community Investment:

Signed by William B. Shear: 

List of Congressional Requesters:

The Honorable Hillary Rodham Clinton 
United States Senate:

The Honorable Susan Collins 
United States Senate:

The Honorable Christopher J. Dodd 
United States Senate:

The Honorable Tom Harkin 
United States Senate:

The Honorable James M. Jeffords 
United States Senate:

The Honorable Edward M. Kennedy 
United States Senate:

The Honorable John F. Kerry 
United States Senate:

The Honorable Patrick J. Leahy 
United States Senate:

The Honorable Carl Levin 
United States Senate:

The Honorable Jack Reed 
United States Senate:

The Honorable Paul E. Kanjorski 
House of Representatives:

The Honorable James A. Leach 
House of Representatives:

The Honorable John M. McHugh 
House of Representatives:

The Honorable Jack Quinn 
House of Representatives:

[End of section]

Appendixes: 

Appendix I: Objectives, Scope, and Methodology:

Our objectives were to: (1) describe the characteristics of selected 
federally sponsored Community and Economic Development CED lenders; (2) 
describe the characteristics of selected federal programs that support 
CED lenders; (3) describe selected efforts to securitize economic 
development loans; (4) determine the barriers to securitizing economic 
development loans; and (5) identify options for overcoming these 
barriers, as well as the implications of the identified options. We 
limited the scope of our work to securitization and did not include 
alternative means for lenders to access private capital.

CED Lender Characteristics and the Performance of their Loans:

Our review focused on the seven types of federally sponsored CED 
lenders that we were specifically requested to include and identified 
as key CED lenders.[Footnote 45] They are the following:

* Community Development Financial Institutions (CDFIs),

* Revolving Loan Funds (RLFs),

* Intermediary Relenders (IRPs),

* Community Development Corporations (CDCs),

* Small Business Administration's (SBA) 504 Certified Development 
Companies (504 CDCs),

* lenders supported by entitlement city and state grantees under the 
U.S. Department of Housing and Urban Development's (HUD) Community 
Development Block Grant Program and lenders supported by the Section 
108 Loan Guarantee program, and:

* microlenders.

To describe the characteristics of selected federally sponsored CED 
lenders, we reviewed and synthesized studies, reports, data, and 
information from industry nonprofits, trade associations, and federal 
program data on selected CED lenders and lending programs. We also 
interviewed CED lenders, their trade associations, and other industry 
groups. We then used the information collected from the identified 
sources to document and describe, where available, the following:

* purpose of (mission) and target markets served by the lender group;

* lender's sources of capital;

* characteristics of the lender group (for example, number of loans, 
amount of loans);

* reported impacts on target markets served; and:

* attempts to measure and define demand for liquidity and capital.

Finally, we documented the availability of data describing the 
characteristics and performance of the loans that CED lenders make. 
Loan performance data were inconsistently available for all lender 
groups; therefore, we were unable to assess the performance of CED 
loans in general. However, we were able to document differences in how 
loan performance was measured. We also identified three current efforts 
to collect loan-level data on CED loans made by select CED lenders in 
EDA, HUD, and Treasury's CDFI Fund. We attempted to obtain summary data 
from these sources on the dollar amount and number of loans in default 
in order to estimate a cumulative default rate for each program. 
However, Treasury's CDFI Fund data were inconsistent and incomplete for 
our analysis. Comparable data on HUD loans were not available at the 
time of this report. We did not independently verify the data, but we 
corroborated it against various sources.

Selected Federal CED Programs:

Our review focused on 11 federal programs that support the seven types 
of CED lenders targeted.[Footnote 46] Programs selected for review, the 
lenders they fund, and the agencies that administer them are listed in 
table 9.

Table 9: Federal CED Lending Programs, Lender Types, and Sponsoring 
Agencies Included in Our Review:

Federal program: Intermediary Relending program (IRP); Lender type: 
IRPs; Sponsoring agency: U.S. Department of Agriculture (USDA).

Federal program: Rural Business Enterprise Grant program (RBEG); Lender 
type: RLFs; Sponsoring agency: USDA.

Federal program: Economic Adjustment Assistance Program; Lender type: 
RLFs; Sponsoring agency: U.S. Department of Commerce Economic 
Development Administration (EDA).

Federal program: Business Development Revolving Loan Fund program; 
Lender type: RLFs; Sponsoring agency: Appalachian Regional Commission 
(ARC).

Federal program: Community Development Block Grant (CDBG) (entitlement 
cities and state-administered); Lender type: Local lenders; Sponsoring 
agency: U.S. Department of Housing and Urban Development (HUD).

Federal program: Section 108 loan guarantee; Lender type: Local 
lenders; Sponsoring agency: HUD.

Federal program: Community Services Block Grant (CSBG); Lender type: 
Local lenders; Sponsoring agency: U.S. Department of Health and Human 
Services (HHS).

Federal program: Enterprise Community/Empowerment Zone Grant (EZ/EC); 
Lender type: RLFs; Sponsoring agency: USDA, HHS, and HUD.

Federal program: Community Development Financial Institution Fund, 
Financial Component (FA); Lender type: CDFIs; Sponsoring agency: U.S. 
Department of Treasury (Treasury).

Federal program: 504 Certified Development Company (504 CDC); Lender 
type: Certified Development Companies (CDCs); Sponsoring agency: Small 
Business Administration (SBA).

Federal program: Microloan Program; Lender type: Microlenders; 
Sponsoring agency: SBA.

Source: GAO.

[End of table]

For each program we analyzed the following:

* purpose and target markets served by the program,

* how the federal government supports the CED lending program,

* restrictions on the use of the federal funds,

* types of performance and lender activity information that the program 
collects,

* volume of program activity, and:

* budgetary costs of funding the program's CED lending activity.

Selected Securitization Efforts for CED Loans:

Our review focused on eight models--five existing and three proposed--
that are intended to serve small business and CED lenders. SBA's 7(a) 
guaranteed and unguaranteed models and the two HUD Section 108 models 
were specifically requested. The remaining four models were identified 
through our contacts with agency officials and other parties.

The five existing models are:

1. SBA's 7(a) guaranteed model,

2. SBA's 7(a) unguaranteed model,

3. SBA's 504 model,

4. HUD's Section 108 model,

5. The Community Reinvestment Fund's (CRF) model:

The three proposed models are:

1. HUD's proposed CDBG/Section 108 unguaranteed model for securitizing 
CED loans,

2. Commonwealth Development Associates' (CDA) proposed model for 
securitizing CED loans,

3. Capital Access Group's proposed securitization model, building on 
existing state-level Capital Access lending programs:

For each of the models, we then collected and summarized information 
about the following:

* models' structure, including lenders and borrowers served;

* securitized volume of each model;

* loan types included in the models' loan pools;

* financial benefits and risks to the participants in the models; and:

* barriers to securitization the models faced.

Barriers to CED Loan Securitization:

To identify barriers to securitization, their causes and proposed 
solutions, we (1) reviewed and synthesized studies and reports obtained 
from literature searches completed on securitization of economic 
development loans and selected sources we thought were most relevant to 
our review; (2) relied on relevant documents and studies identified in 
interviews with program officials, lenders, and their trade 
associations referred to previously; and (3) pinpointed barriers faced 
in the eight securitization models reviewed and the extent to which the 
barriers have been overcome. We limited our review to those documents 
that identified barriers to CED loan securitization and did not include 
those that discussed barriers to accessing capital through other means. 
We synthesized information on barriers in these documents into a single 
matrix uncovering over 264 citations of barriers to securitization, 
their causes, and any proposed solutions. We then developed logical 
groupings that characterized the barriers and assessed the reliability 
of these groupings by having teams of two independently code them and 
reach consensus on areas where original coding did not agree. The six 
categories that appear in this report are as follows:

* uncertain borrower demand and limited lender interest,

* insufficient lender capacity,

* external requirements attached to capital sources,

* below-market-rate loan products will not meet market requirements 
without a discount or subsidy,

* lack of standardization and inadequate performance information, and:

* limited mechanisms available to support securitization for CED loans.

Options for Securitization and Their Implications:

We relied upon the proposed solutions identified in the barrier 
analysis described above and our professional judgment to identify 
strategies for overcoming barriers to securitizing economic development 
loans. We considered a range of options available to the federal 
government to address the barriers developed in our analysis. Federal 
options generally include the following:

* potential modification(s) of legal or program requirements,

* potential incentives within existing programs to promote participant 
interest and/or the ability to securitize, and:

* potential actions to help improve lender capacity.

We do not endorse the options we identified and, given the scope of 
this report, note that these options are designed to address barriers 
to securitization, rather than improving access to capital through 
other means.

We also used our professional judgment and that of experts in the field 
to determine the potential implications of each option. We developed a 
range of implications based upon our research and discussions with 
program and industry experts. The potential implications of the options 
generally considered whether the option could result in:

* conflicts with lenders' mission,

* need for new federal funding or resources,

* direct and/or immediate impact on the barrier being targeted, and/or:

* improved lender or program management.

While we recognize that options could entail additional federal costs, 
we do not determine whether the benefits exceed the costs that could 
result from such efforts.

Our work was conducted in Manchester, New Hampshire; Philadelphia, 
Pennsylvania; and Washington, D.C., between October 2002 and July 2003 
in accordance with generally accepted government auditing standards. We 
obtained comments on a draft of this report from U.S. Department of 
Agriculture; U.S. Department of Commerce; U.S. Department of Housing 
and Urban Development; U.S. Department of Treasury; U.S. Small Business 
Administration; U.S. Department of Health and Human Services; and the 
Appalachian Regional Commission which we incorporated into the report, 
where appropriate.

[End of section]

Appendix II: Model Descriptions:

Model: SBA 504 program; Lenders: Certified Development Companies; 
Borrowers: Creditworthy, for-profit small businesses who have qualified 
for conventional loans; Model structures: In existence since 1986, the 
SBA 504 program provides creditworthy small businesses with fixed-rate, 
long-term subordinate loans, primarily for commercial real estate (not 
to exceed 40 percent of the total loan amount). A third-party lender 
must provide at least 50 percent of the project amount. Each 504 CDC 
loan is funded by a guaranteed debenture and sold by SBA's designated 
trust agent, who pools them and issues U.S. Government Guaranteed 
Development Company Participation Certificates. These certificates are 
sold to investors through underwriters with timely payment of principal 
and interest guaranteed by SBA.

Model: SBA 7(a) guaranteed; Lenders: Commercial banks, credit unions, 
small business lending companies and other nonbank lenders; Borrowers: 
For-profit small businesses that could not obtain financing elsewhere; 
Model structures: SBA has been authorized to securitize 7(a) guaranteed 
loans since 1984. The program provides a guarantee on a portion of a 
small business loan ranging from 50 percent to 85 percent, following 
SBA's review and approval of each loan unless originated by a preferred 
lender. The lender may elect to sell the guaranteed portion of each 
loan to an SBA-approved loan pool assembler, which issues SBA-
guaranteed securities to investors. Working capital, equipment, and 
real estate loans may be included in these loan pools, which normally 
carry a variable interest rate.

Model: SBA 7(a) unguaranteed; Lenders: Commercial banks, credit unions, 
small business lending companies and other nonbank lenders; Borrowers: 
For-profit small businesses that could not obtain financing elsewhere; 
Model structures: SBA first authorized the sale of unguaranteed 
portions of 7(a) loans on the secondary market in 1992. On February 10, 
1999, SBA issued a Final Rule that created a new regulatory regime for 
all participating lenders in this program. Lenders pool their loans and 
issue securities to investors that include internal credit enhancements 
provided by the lender. To date, each security has been rated as 
investment-grade by credit rating agencies.

Model: HUD Section 108 guaranteed; Lenders: CDBG grantees and their 
designated lenders; Borrowers: For-profit or nonprofit borrower; Model 
structures: Operating since 1978, the Section 108 permanent financing 
program provides both the actual financing for the securities and a 100 
percent federal credit enhancement. Payments on the loans are passed 
through to the Section 108 note holders. The principal security for the 
loan guarantee is a pledge by the applicant community or the state (for 
nonentitlement communities) of its current and future CDBG funds. 
Additional security will also be required by CDBG grantees to assure 
repayment of the guaranteed obligations.

Model: Community Reinvestment Fund (CRF); Lenders: Nonprofit, for-
profit, and governmental community development lenders; Borrowers: 
Local business, affordable housing, and community facility borrowers; 
Model structures: CRF is a nonprofit secondary market maker for CED-
based lenders nationwide and has issued securities since 1991. It 
purchases and warehouses loans from community lenders and uses the 
loans to back securities issued to private investors through private 
placements. These securities include a variety of credit enhancements, 
including subordinated tranches that are typically financed with loans 
and grants from private foundations.

Model: Proposed Commonwealth Development Associates (CDA); Lenders: 
Nonprofit, for-profit, and governmental community development 
lenders; Borrowers: Small business borrowers not served by local 
commercial financial institutions; Model structures: CDA was part of 
the Economic Development Administration's securitization pilot in 2000. 
CDA proposed to pool economic development loans and acquire a rating 
using a credit-scoring model. Under the CDA model, loan originators 
were to hold the loans until enough loans became available for a rating 
and sale as a private placement, with partial internal credit 
enhancements funded by each participating lender, as well as external 
enhancements funded with public or private monies. Since CDA was unable 
to achieve the minimum loan volume required by the credit rating 
agency, the model was never implemented.

Model: Proposed; CDBG/108 unguaranteed; Lenders: CDBG-grantees and 
their designated lenders; Borrowers: For-profit or nonprofit borrower; 
Model structures: Under contract with HUD, the Urban Institute has 
proposed a structured finance securitization model that includes a 
small senior tranche, a large subordinated tranche, and a residual 
retained by the loan seller equal to about 20 percent. This assumes 
that a bank has provided 35 percent of the project cost with a senior 
collateral position. The remaining 55 percent has been provided by the 
community with either Section 108 or CDBG funds in a junior collateral 
position. The senior tranche would be sold to investors as an 
investment-grade security. An alternative is to include the senior bank 
loan portion in the loan pool, thereby also increasing the size of the 
senior tranche.

Model: Proposed; Capital Access Program variation; Lenders: CDFI 
lenders; Borrowers: Minority businesses, nonprofits, and commercial 
real estate properties; Model structures: Proposes to purchase 
subordinated loans to small businesses and nonprofit organizations (25-
40 percent of total loan amount), that would require 100 percent 
financing, assuming a commercial bank agrees to provide the remaining 
60-75 percent as a senior collateral position. Only the subordinate 
loan would be sold as securities, with primarily the borrower and 
possibly the lender, the state, or the federal government providing the 
necessary credit enhancements to investors.

Sources: SBA, HUD, CRF, CDA, Capital Access Croup.

[End of table]

[End of section]
(250103):

FOOTNOTES

[1] Broadly, securitization is a process whereby lenders and others 
create pools of loans and sell to investors securities that are backed 
by cash flows from these loan pools--thereby replenishing funds 
available for lending. 

[2] Lender liquidity is a measure of a lender's ability to meet its 
current financial obligations. It implies that the quality of the 
lender's assets are such that they can be readily converted into cash 
with minimal loss in market value. 

[3] Our review does not include lenders identified as Certified 
Development Enterprises financed through the Department of Treasury's 
New Markets Tax Credit because these entities were only recently 
established. 

[4] The seven groups of lenders reviewed are (1) Community Development 
Financial Institutions (CDFIs); (2) Revolving Loan Funds (RLFs); (3) 
Intermediary Relenders funded by the Department of Agriculture's 
(USDA's) Intermediary Relending Program (IRPs); (4) Community 
Development Corporations (CDCs); (5) Small Business Administration 
(SBA) 504 Certified Development Companies (504 CDCs); (6) microlenders; 
and (7) lenders supported by Community Development Block Grant (CDBG) 
entitlement and state grantees.

[5] The five existing models include those for securitizing SBA 504 
program loans, unguaranteed SBA 7(a) loans, guaranteed SBA 7(a) loans, 
and HUD Section 108 guaranteed loans, and the securitization model used 
by the Community Reinvestment Fund--a nonprofit secondary market maker 
for CED-based lenders nationwide. We also reviewed three models 
proposed by various sources--Commonwealth Development Associates' 
(CDA) model proposed under the EDA 2001 securitization demonstration, 
HUD's proposed CDBG /Section 108 model, and Capital Access Group's 
proposed Capital Access Program securitization model.

[6] A credit enhancement is a payment support feature that covers 
defaults and losses up to a specific amount, thereby reducing investor 
need for loan-specific information. It acts to increase the likelihood 
that investors will receive interest and principal payments in the 
event that full payment is not received on the underlying loans.

[7] In the case of a loan default, providers of subordinate financing 
have a claim to borrower assets that is junior, or secondary, to the 
claims of the provider of the senior financing.

[8] Anand K. Bhattacharya and Frank J. Fabozzi, ed., Asset-Backed 
Securities, (New Hope, Pennsylvania: Frank J. Fabozzi Associates, 
1996).

[9] Congress established and chartered Fannie Mae and Freddie Mac as 
government-sponsored, privately owned and operated corporations to 
enhance the availability of mortgage credit across the nation during 
both good and bad economic times. Congress established Ginnie Mae as a 
government-owned corporation within HUD responsible for activities 
including guaranteeing mortgage-backed securities backed primarily by 
cash flows from Federal Housing Administration and Department of 
Veterans Affairs mortgages.

[10] Consumer credit receivables include assets such as auto loans and 
credit card receivables.

[11] Congress passed the Riegle Community Development and Regulatory 
Improvement Act (Riegle Act) in 1994 to remove several legal and 
regulatory impediments to small business and commercial mortgage 
securitizations, including favorable regulatory capital treatment for 
depository institutions, and preemption of state securities 
registration and investment restrictions. This data is from the Federal 
Reserve Board and includes pools of nonguaranteed portions of SBA 7(a) 
loans and pools of other non-federally guaranteed loans.

[12] Federal Reserve Board. Includes pools of guaranteed portions of 
SBA 7(a) loans.

[13] Federal Reserve Board. The board notes that their 1998 Survey of 
Small Business Finance indicates that commercial bank small business 
loans outstanding represents roughly 65 percent of all small business 
lending.

[14] U.S. General Accounting Office, Small Business Administration: 
Size of the SBA 7(a) Secondary Markets Is Driven by Benefits Provided, 
GAO/GGD-99-64 (Washington, D.C.: May 26, 1999).

[15] The National Congress for Community Economic Development, a trade 
association for Community Development Corporations conducts a survey on 
these lenders. The next survey is not scheduled for completion until 
2004.

[16] Data on the total number of RLFs and HUD-supported lenders are 
unavailable. RLFs do not have a central organization that maintains 
data on the RLF industry as a whole. While an attempt to collect RLF 
data was made by the Corporation for Enterprise Development in 1997, it 
was not successful because reliable data were not available at that 
time on many of the RLFs. Also, RLFs funded by HUD's CDBG program were 
excluded from the count. HUD's recent attempt to identify its grantees 
using Section 108 and CDBG dollars for CED lending resulted in the 
identification of 1,012 state and local entitlement grantees. However, 
because these grantees make direct loans to businesses and to nonprofit 
intermediaries (such as RLF lenders), identified grantees do not 
represent the universe of the lenders supported by the programs.

[17] Delinquency refers to a situation where an entity falls behind 
agreed payment dates in making payments. Defaults occur when the lender 
no longer believes that the business will make payments. Losses are the 
monetary losses to the loan holder in the event of borrower default, 
less any monetary value recovered from the liquidation of loan 
collateral.

[18] These data should be viewed carefully. Data on loan performance 
are derived from semiannual reports prepared by RLFs. According to EDA 
officials, use of RLF grant money may not be covered by RLF audits. We 
did not assess the reliability of these data.

[19] HHS also administers the Community and Economic Development 
Discretionary Grant Program. According to HHS officials, beginning in 
2000, these grants may be used for funding RLFs. In 2002, HHS made 
fewer than 10 grants to RLFs under this program. 

[20] For the 504 CDC program, loan repayments go directly to investors 
and are, therefore, unavailable for relending.

[21] SBA sets the interest rate on 504 CDC loans.

[22] HHS's CSBG and EZ/EC programs are among these. According to HHS 
officials, Illinois is the only state that uses HHS CSBG funds for the 
purpose of economic development activities such as establishing RLFs.

[23] SBA's Microloan program allows grant funds to be used only for 
technical assistance and training of microborrowers and potential 
microborrowers. According to SBA officials, such technical assistance 
is sometimes viewed as a substitute for collateral and is intended to 
help ensure repayment of Microloans.

[24] The 504 CDC makes its loans with proceeds from a guaranteed 
debenture. Loan payments owed to the 504 CDC match the payments the 504 
CDC owe investors under the debenture. If the borrower defaults, SBA 
buys the debenture back from the investors. Lenders must reimburse SBA 
for 10% of the loss it incurs in connection with the 504 CDCs's default 
on the debenture.

[25] Appalachia includes all of West Virginia and parts of 12 other 
states: Alabama, Georgia, Kentucky, Maryland, Mississippi, New York, 
North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, and 
Virginia. The term "economically distressed" is defined differently 
among programs. For instance, EDA defines economically distressed as 
urban or rural communities that are experiencing high unemployment, low 
per capita income, and other conditions, including sudden economic 
dislocations due to industrial restructuring and relocations or natural 
disasters. Other programs may use different terminology to indicate 
targeted economically distressed areas.

[26] ARC's Business Development program allows borrowers to be located 
outside of the Appalachian region; however, the business or project to 
be funded must provide jobs or other economic benefits within the 
region.

[27] A borrower may also use Microloan proceeds to establish a 
nonprofit child care business.

[28] However, grantees can graduate to annual reporting upon consent of 
the agency.

[29] The only exception to this is the CSBG program. According to HHS 
officials, Illinois is the only state in the country that uses CSBG 
funds for economic development lending purposes. The program has 38 
local Community Action Agencies operating RLFs. The program 
administrator told us that he is intimately familiar with the lenders 
and their loan portfolios. As indicated in figure 2, performance data 
for CDFIs is currently collected at the aggregate level. However, 
Treasury has recently proposed that CDFIs report performance 
information annually at the loan level.

[30] In providing comments on the report, HUD officials informed us 
that while they do not get information on loan performance data 
targeted in our report, HUD's Integrated Disbursement and Information 
System includes information on the type of assistance provided and the 
terms of assistance including interest rates and amortization periods.

[31] The Illinois CSBG program also maintains data on lender activity 
in a database in a central office. We were unable to document the 
extent to which SBA maintains data on loans made by lenders supported 
in its 504 CDC program and Microloan programs.

[32] Program-related investments include loans, loan guarantees, 
mortgage investments, and equity investments that are made by 
foundations such as the Ford Foundation or MacArthur Foundation for 
many CED purposes, to multiple CED entities. The foundation can receive 
favorable tax treatment from the IRS if the Program-related investments 
receive below-market-rates of return. Program-related investments can 
provide financial benefits to the foundation, as well as further the 
mission of the foundation and the receiving CED entities.

[33] Prudent person rules allow investment managers or fiduciary 
trustees the flexibility to make financial decisions regarding asset-
types and rates of return that an ordinary, reasonably well-informed 
person would exercise. Prudent person rules tend to discourage 
speculative transactions, placing the potential for higher incomes and 
capital gains in a secondary position to preservation of capital.

[34] For example, CDFI 's trade association noted a "deployment rate," 
which is used as a proxy for the percentage of loanable funds that are 
actually loaned out.

[35] Kelly Robinson, "Expanding Capital Resources for Economic 
Development: An RLF Demonstration." (Washington D.C.: Economic 
Development Administration, 2001).

[36] A review of trends in HUD's unexpended balance report shows 
expiring balances in the program going from $22.6 million in 1997 to 
$109.2 million in 2001. These were 1-year appropriations that were not 
used at the end of the period. According to HUD, for the past several 
years, the actual demand for the program has been substantially below 
the loan guarantee level requested or provided in appropriations. HUD 
also recognized that grantees have not utilized the program at higher 
levels in part because of their reluctance to pledge future grant funds 
as collateral.

[37] These collateral requirements refer to the additional security 
Section 108 borrowers must provide beyond the pledge of future CDBG 
program funds.

[38] Brody, Weiser, Burns Business and Organizational Consulting, 
Strategies to Increase Community Development Finance--a Ford Foundation 
CDFI, Study Phase II, January 2002.

[39] These national objectives include benefiting low-and moderate-
income persons, preventing or eliminating slums or blight, and 
addressing conditions that pose a serious and immediate threat to the 
heath and welfare of communities served.

[40] Many institutional investors, such as banks and pension funds are 
generally restricted to "investment-grade" securities (nonspeculative 
securities with higher credit ratings). One hundred percent 
governmental guarantees can also provide adequate assurance to 
institutional investors without a credit rating on the pool of assets. 
Investors willing to take on more risk can invest in lower-rated, or 
nonrated securities.

[41] Securities raters have traditionally required at least several 
hundred similar loans or assets in a pool in order to create a risk 
profile for the pool using statistical analysis. Statistical analysis 
is generally more cost-effective for securities raters on a per loan 
basis than other methods of analysis.

[42] Many securitizations require originating lenders to assume first-
loss positions or use other internal credit enhancements to provide 
credit support to the investment-grade securities.

[43] Some of the loans securitized under the Section 108 program are 
used to fund smaller loans to individual businesses through RLFs and 
nonprofit intermediaries such as CDCs.

[44] In providing technical comments, HUD suggested that fees could be 
but are currently prohibited from being charged to create a loan loss 
reserve for securitizing these loans. However, we did not assess the 
implications of this option.

[45] Although we identified one other lender group--Community 
Development Entities under Treasury's New Markets Tax Credit--we did 
not review these lenders because Treasury just recently (2002) 
established Community Development Entities, and limited information was 
available on them. 

[46] While there are other federal programs that support economic 
development activity, we focused on those within the seven federal 
agencies we were requested to review that support seven types of CED 
lenders targeted. For example, HHS administers the Community and 
Economic Development Discretionary Grant program. However, the program 
could only recently be used to fund RLFs. Also, see previous footnote.

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