VENTURE CAPITAL MARKETING ASSOCIATION
CHARTER ACT
Y4.Sri 1:104-73
Denture Capital llarketing dssocUti...
HEARING
BEFORE THE
SUBCOMMITTEE ON GOVERNMENT PROGRAMS
OF THE
COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTH CONGRESS
SECOND SESSION
WASHINGTON, DC, APRIL 18, 1996
Printed for the use of the Committee on Small Business
Serial No. 104-73
msfmy
iBu
U.S. GOVERNMENT PRINTING OFFICE
24-131 CC WASHINGTON : 1996
For sale by the U.S. Government Printing Office
Superintendent of Document.s, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-053420-8
^ N VENTURE CAPITAL MARKETING ASSOCIATION
^ CHARTER ACT
'y4.SM 1:104-73
Denture Cjfifl «"Keti«9 (Issociati. . .
HEARING
BEFORE THE
SUBCOMMITTEE ON GOVERNMENT PROGRAMS
OF THE
COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTH CONGRESS
SECOND SESSION
WASHINGTON, DC, APRIL 18, 1996
Printed for the use of the Committee on Small Business
Serial No. 104-73
OCT ; / 1336
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1996
For sale by the U.S. Government Printing Office
Supenntendent of Documents. Congressional Sales Office, Washington, DC 20402
ISBN 0-16-053420-8
COMMITTEE ON SMALL BUSINESS
JAN MEYERS, Kansas, Chair
JOHN J. LaFALCE, New York
IKE SKELTON, Miaeouri
NORMAN SISISKY, Vir^nia
FLOYD H. FLAKE, New York
GLENN POSHARD, Illinois
EVA M. CLAYTON, North Carolina
MARTIN T. MEEHAN, Massachusetts
NYDIA M. VELAZQUEZ, New York
CLEO FIELDS, Louasiana
EARL F. MILLIARD, Alabama
DOUGLAS "PETE" PETERSON, Florida
BENNIE G. THOMPSON, Mississippi
KEN BENTSEN, Texas
WILLIAM P. LUTHER. Minnesota
JOHN ELIAS BALDACCI, Maine
JOEL HEFLEY, Colorado
WILLIAM H. ZELIFF, JR., New Hampshire
JAMES M. TALENT, Missouri
DONALD A. MANZULLO, Illinois
PETER G. TORKILDSEN, Massachusette
ROSCOE G. BARTLETT, Maryland
LINDA SMITH, Washington
FRANK A. LOBIONDO, New Jersey
ZACH WAMP, Tennessee
SUE W. KELLY, New York
DICK CHRYSLER, Michigan
JAMES B. LONGLEY, JR., Maine
WALTER B. JONES, JR., North Carolina
MATT SALMON, Arizona
VAN HILLEARY, Tennessee
MARK E. SOUDER, Indiana
SAM BROWNBACK, Kansas
STEVEN J. CHABOT, Ohio
SUE MYRICK, North Carolina
DAVID FUNDERBURK, North Carohna
JACK METCALF, Washington
STEVEN C. LaTOURETTE, Ohio
Jenifer Loon, Sta/f Director
Jeanne M. RoslanowicK, Minority Staff Director
Subcommittee on Government Programs
PETER G. TORKILDSEN, MasschusetU. Chairman
JOEL HEFLEY, Colorado
SUE MYRICK, North Carolina
SUE W. KELLY, New York
DICK CHRYSLER, Michigan
DAVID FUNDERBURK, North Carolina
STEVEN C. LaTOURETTE, Ohio
GLENN POSHARD, Illinois
CLEO FIELDS, Louisiana
BENNIE G. THOMPSON, Mississippi
Laurie Rains, Subcommittee Sta/f Director
(II)
CONTENTS
Page
Hearing held on April 18, 1996 1
WITNESSES
Thursday, April 18, 1996
Clare, Michael, Department Head for Asset-Backed and Government-Backed
Securities, Chase Securities, Inc 7
Dunbar, William F., President, Allied Capital Corporation II 2
Murray, Jim, Counsel, Brown & Wood 9
Rafferty, Raymond R., Jr., (General Partner, Meridian Venture Partners 5
Zegart, Joel, President, JBS & Associates 10
APPENDIX
Opening statements:
Torkildsen, Hon. Peter G 15
Poshard, Hon. Glenn 19
Prepared statements:
Clare, Michael 20
Dunbar, William F 27
Murray, Jim 81
RafTerty, Raymond R., Jr 87
Zegart, Joel 90
(III)
VENTURE CAPITAL MARKETING ASSOCIATION
CHARTER ACT
THURSDAY, APRIL 18, 1996
House of REPRESE^^^ATIVES,
Subcommittee on Government Programs,
Committee on Small Business,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in room
2359, Raybum House Office Building, the Honorable Peter
Torkildsen (Chairman of the Subcommittee), presiding.
Chairman Torkildsen. Good morning. As Chairman of the Small
Business Subcommittee on Government Programs, it is a pleasure
to welcome our guests here today.
The purpose of this hearing is to discuss H.R. 2806, the Venture
Capital Marketing Association Charter Act, also known as Vickie
Mae, which I introduced during the first session of this Congress,
and also to discuss the privatization model that led to this legisla-
tion.
Privatization has been a subject of much debate in this Congress
and in previous Congresses. It is important that we recognize that
there are functions that the Federal Government now performs
that would be better off in the hands of the private sector.
We must be selective in our efforts to privatize Government func-
tions. This is one area, though, where privatization may make very
good sense.
The current SBIC Program is a unique partnership between the
private sector and the Federal Government. SBIC's are capitalized
with private funds and managed by skilled professionals in the
venture capital field who make their investment decisions without
overt interference from Grovernment.
The U.S. Small Business Administration currently oversees
SBIC's. Although the program is sound, there is still room to grow
and improve.
The model to privatize the SBIC Program brings that oppor-
tunity to grow. The proposal to privatize creates a Government-
sponsored enterprise, nicknamed Vickie Mae, that would be statu-
torily chartered by Congress to act as a capital bank for the SBIC
industry.
The new corporation would replace the SBIC Program functions
now performed by the SBA. It would create a dependable flow of
funds to SBIC's at reasonable cost. Finally, it would provide an im-
proved operating environment for SBIC's to conduct business.
(1)
Above all, the privatized system would give small business in-
creased access to venture capital markets, markets that are often
closed to them.
Clearly, through privatization, our goal is to give small business
more access to the capital market, but this legislation specifically
focuses on taking the existing SBIC Program and transforming it
to a new off-budget Grovernment-sponsored enterprise.
This enterprise has the potential to save the taxpayers an esti-
mated $185 million over 5 years. It is necessary to take steps in
this direction as the Congress works to balance the Federal budget.
I'm interested in hearing the testimony of our witnesses today on
a variety of issues, including liquidation, the legal characteristics
of creatmg GSE's, the issue of selling bonds in the open market,
and the market's acceptance of these securities, and finally, the
comments of a community SBIC representative.
At this time I will note that my colleague and ranking member,
Mr. Poshard, is not here. He is on his way and when he does ar-
rive, I will recognize him for an opening statement if he wishes to
make one.
Our witnesses today are Will Dunbar, President of Allied Capital
Corporation II here in Washington, DC; Raymond Rafferty, a Gen-
eral Partner in Meridian Venture Partners; Michael Clare, Depart-
ment Head responsible for Asset-Backed and Government-Backed
securities at Chase Securities, Incorporated in New York; James E.
Murray, Counsel in the Washington office of Brown & Wood; and
Joel Zegart, Founder and President of JBS &, Associates.
I'd like to start with Mr. Dunbar. For all the witnesses I'll note
please feel free to summarize. We'll ask that you keep your com-
ments to 5 minutes and your written statement will appear in the
record in its entirety and that will perhaps allow more time for
questions.
Mr. Dunbar.
TESTIMONY OF WILLIAM F. DUNBAR, PRESIDENT, ALLIED
CAPITAL CORPORATION II
Mr. Dunbar. Thank you, Mr. Chairman and good morning. I ap-
preciate the opportunity to be here today on behalf of the National
Association of Small Business Investment Companies, the associa-
tion representing the SBIC industry.
In my professional capacity I am President of the Washington,
DC-based Allied Capital Corporation II and of Allied Investment
Corporation II, a wholly owned subsidiary which is an SBIC with
$10 million in funded capital. I also serve as Executive Vice-Presi-
dent of all the other funds managed by Allied Capital Advisers,
which includes another SBIC, which happens to be the oldest SBIC
in the country, and an SSBIC.
I would like at this point to, with the Chairman's permission,
submit my written testimony for the record and summarize with
some brief oral comments.
Mr. TORKILDSEN. Without objection, so ordered.
Mr. Dunbar. I'd like to begin by commending Chairman
Torkildsen for sponsoring H.R. 2806, the Venture Capital Market-
ing Association Charter Act, and for holding this hearing today. We
believe the demonstrated lack of sufficient long-term patient cap-
ital for America's small businesses and the circumstances relating
to today's SBIC Program make the creation of Vickie Mae, as we've
called it, in the near future a winning path for all involved.
That would include U.S. taxpayers who want their Government
to ensure a flow of capital to small businesses, pursuant to a safe
and cost-effective program, private investors who are willing to pro-
vide both initial and leverage capital to SBIC's if they believe the
program has stability and reliability, and the small businesses that
will use the capital to create tomorrow's jobs and the new tech-
nologies necessary to ensure our continuea competitive position in
an increasingly global economy.
In our opinion, H.R. 2806 has three primary benefits. First of all,
it would reduce the sizt and budgetary cost to the Federal Grovern-
ment. It's clear that this has been a consistent theme of this Con-
gress for the last year and a half. Although estimates vary, our es-
timates are that the savings in tax dollars would total approxi-
mately $200 million over the next 5 years.
It would move the pro-am into the private sector, eliminating
the Government's direct management and guarantor status. It
would continue a trend toward total privatization which really
began back in the 1980's when the program moved from direct
funding by the Treasury to a structure whereby SBA guarantees
debentures issued to the private capital market investors.
Following that, between 1992 and 1994, the SBIC Program was
overhauled to increase the amount of private capital and to de-
crease the maximum SBA leverage for each SBIC. We believe that
this, the creation of a GSE, would be the next logical step and
could lead ultimately to total privatization and elimination of
Vickie Mae's GSE status at some point in the future.
The second broad benefit we see is that it would enable the SBIC
program to achieve its full potential in providing long-term patient
capital to U.S. small businesses. Since the 1994 overhaul, there's
been significant growth in the program; however, it has been ham-
pered by restricted appropriations for leverage and management
restrictions at SBA.
During the last 2 years, there have been 57 new SBIC's licensed
which have brought to the table approximately $830 million in pri-
vate capital, which is more than the entire program raised over the
last 15 years. Currently there are 76 license applications pending.
The total of these new and pending SBIC licenses represent pri-
vate capital of approximately $1.5 billion. If that private capital
were leveraged 2 to 1, the total capital available for investment in
small business would total approximately $5 billion. At $500,000
per investment, that equals 10,000 additional small businesses that
would receive investment capital for growth and hundreds of thou-
sands of new jobs created and tax dollars generated.
However, the current funding levels fall well short of these goals.
In addition, there are many more participants who would enter the
program but for the uncertainty of the funding process in the cur-
rent structure.
The uncertainty is particularly acute because small business in-
vesting is, by definition, a long-term process. You must plan over
a 5 or 10 year horizon, but that is really impossible in the current
structure. Vickie Mae would make it subject to private sector mar-
ket forces, which would be much more predictable over a long pe-
riod of time.
We believe that the overhauled SBIC Program is poised to make
a dramatic contribution to America's business base if it can reach
its full potential.
The third major benefit that we see is that the creation of Vickie
Mae and continued growth of the SBIC Program would enhance
the safety and soundness of the overall program and reduce the
risk for the Government.
First of all, it would enable SBIC managers, as I described ear-
lier, to plan their total capital base over the life of the fund, which
would enable them to properly diversify their portfolio as appro-
priate, to maximize returns and minimize risk.
Growth of the program also reduces the risk because the larger
number of participants reduce relatively the potential exposure to
risk from any one participant.
The venture economic study that we cite in our model that covers
the 14-year period from 1976 to 1989 showed that there was not
a single year in which the venture capital industry as a whole lost
money, although there were periods of time when certain funds lost
money.
Next, it creates another layer of cushion that protects the Fed-
eral Government because not only is private capital of each SBIC
at risk, but also the full capitalization of Vickie Mae would be
available to fund losses. Our estimates are that initial capital
would be $20 million, which grows, in our model, to nearly $500
over the first 10 years of Vickie Mae's existence. In actuality, our
financial model assumes more conservative projections than the
venture economic study that covered the 14-year period I cited.
In conclusion, creating Vickie Mae will allow the SBIC Program,
one of our country's most successful programs, to reach its full po-
tential in helping America's small business entrepreneurs create
the jobs and technologies that are the foundation of America's
greatness.
At the same time it will one, provide a logical context within
which eventual full privatization might be accomplished; second,
increase the safety and soundness of the program by removing un-
certainty and artificial impediments to market forces and installing
the private sector as the insurer of last resort; and third, reduce
the size of Government by properly allocating management and
oversight responsibility between the Government and the private
sectors.
Vickie Mae will permit the SBIC Program to meet its critical
public policy goal through leverage of private sector leadership,
capital and management expertise. As a GSE, Vickie Mae will rep-
resent the best in a partnership between Government and the pri-
vate sector.
Thank you for your time and attention. I will be pleased to an-
swer any questions you might have.
Mr. TORKILDSEN. Thank you, Mr. Dunbar.
Mr. Rafferty.
[Mr. Dunbar's statement may be found in the appendix.]
TESTIMONY OF RAYMOND R. RAFFERTY, JR., GENERAL
PARTNER, MERIDIAN VENTURE PARTNERS
Mr. Rafferty. Thank you, Mr. Chairman. I, too, appreciate the
opportunity to testify on H.R. 2906, the Venture Capital Market
Association Charter Act.
I am a Greneral Partner of Meridian Venture Partners, an SBIC
located in Radnor, Pennsylvania. Meridian has $45 million under
management and Meridian was the first institutional investor to fi-
nance Mother's Work, NASBIC's 1995 Portfolio Company of the
Year. Mother's Work is now a publicly held specialty retailer em-
ploying over 2,000 people in a network of 455 retail stores in 43
States. It is truly a great example of what the SBIC Program can
accomplish for small business.
To my colleague Mr. Dunbar. I commend you for introducing this
legislation. I am firmly of the opinion that creating Vickie Mae is
one of the single greatest steps Congress could take in helping the
small business base of America. That such a result could be
brought about while, at the same time, improving the safety and
soundness of the program, reducing the size and cost of the Gov-
ernment, and moving the program one step closer to full privatiza-
tion demonstrates the real power of the Government-sponsored en-
terprise approach.
In this regard, and as a member of the National Association of
Small Business Investment Companies, I endorse the points that
Mr. Dunbar makes in his testimony.
Mr. Chairman, you have asked me, in my capacity as a general
partner of an active SBIC, to comment specifically on the advan-
tages or opportunities that might be made available to our firm,
particularly in the area of participating securities, if your bill were
enacted. I am happy to do so.
There are two significant advantages that I, as a managing part-
ner of an SBIC, would have that are not associated with the cur-
rent program. I believe that all managers of active SBIC's would
concur with the points I will make.
First, the advantages. The creation of Vickie Mae would result
in the enhanced performance of our fund and thus provide greater
returns to our investors, including Vickie Mae, in the case of par-
ticipating securities, and make Vickie Mae a stronger entity.
Second, the creation of Vickie Mae should make more money
available to more small businesses by increasing the universe of
potential private investors and making it more likely that we
would be able to start another fund or attract additional capital to
our existing fund.
The discussion with regard to those points is as follows. The key
is that Vickie Mae would give us confidence that we would have
a stable flow of leverage capital, subject only to the conditions of
the private capital markets, something we understand, and not to
the vagaries of the political process, something we are attempting
to understand.
Vickie Mae would ensure our leverage through a normal invest-
ment cycle of between 5 and 7 years. This is particularly important
with respect to planing for any follow-on investments that might be
advisable with respect to any of our portfolio companies.
Being assured as to the availability of leverage capital over the
course of a normal investment cycle would better enable us to plan
and manage the investment activity of our fund. That should result
in enhanced performance and greater returns to our investors,
again including Vickie Mae.
This latter result is obviously of particular importance. By in-
creasing Vickie Mae's returns, the organization would grow in
strengtn. Not only would this aid in the sale of Vickie Mae securi-
ties, but it would enable it, we believe, to increase the universe of
purchasers of its securities, unlocking the importation of capital for
the purpose of meeting the needs of domestic small business con-
cerns and, we believe, setting a real prelude to the full privatiza-
tion of Vickie Mae in the future.
The second and related advantage is the increased confidence
that our initial private investors would have in the SBIC Program.
Our business plan is built on the assumption that we will be able
to draw down the maximum leverage capital provided for in the
legislation. If that leverage capital is not certain, our private inves-
tors are less likely to invest their money and less likely to add ad-
ditional private capital to our fund or to another fund already in
existence.
The combination of eliminating the uncertainty and enhancing
returns is a powerful formula. Because of the increased investor
confidence, Vickie Mae would increase the universe of potential pri-
vate investors and make it more likely that we would be able to
start a new fund or attract additional capital to our existing fund.
This would provide MVP, which is how we're known. Meridian
Venture Partners, and other professional SBIC managers a proper
and a powerful incentive to manage and perform well.
Mr, TORKILDSEN. Mr. Rafferty, I have to apologize to the panel.
I have been called to a mark-up vote. With my apologies, I have
to put the subcommittee in recess, subject to the call of the chair.
I would expect it would be about 15 minutes. Again, you have my
apologies but we will reconvene as soon as possible.
Mr. Rafferty. Not a problem.
Mr. TORKILDSEN. The subcommittee stands in recess.
[Recess. 1
Mr. TORKILDSEN. The hearing will reconvene.
Mr. Rafferty, did you have any final comments you wish to
make?
Mr. Rafferty. Yes, Mr. Chairman. In closing, I'd like to say that
in the final analysis, the SBIC Program is successful because the
small businesses that we invest in are successful. It is generally ac-
cepted that more small businesses fail for the lack of capital than
any other reason. The more we can do to address the lack of capital
problem, the better we will be as a Nation.
I believe the legislation you have introduced will make the SBIC
Program a substantially better prc^ram in providing that capital to
a greater number of qualified smallbusinesses.
Thank you again for the opportunity to present my views and I
will be happv to answer any questions you may have now or at any
time in the fiiture. Thank you.
Mr. TORKILDSEN. Thank you, Mr. Rafferty.
Now we'll hear from Mr. Clare.
[Mr. Rafferty's statement may be found in the appendix.]
TESTIMONY OF MICHAEL CLARE, DEPARTMENT HEAD FOR
ASSET-BACKED AND GOVERNMENT-BACKED SECURITIES,
CHASE SECURITIES, INC.
Mr. Clare. Good morning, Mr. Chairman. My name is Michael
Clare. I'm a Managing Director at Chase Securities, Inc. in New
York.
I've been involved with the SBIC Program in a variety of roles
since 1985. Initially I was invited to become part of the Investment
Banking Advisory Group that designed the mechanism that we
continue to use today for the quarterly sales of SBA-guaranteed de-
bentures. Subsequently I was invited to help construct a program
to launch the participating securities.
From the inception of these two securities programs, my col-
leagues and I have been directly involved in bringing to the securi-
ties markets 37 separate debenture offerings worth a little over $1
billion and five separate participating securities offerings worth
$310 million.
The intent of these programs was and remains to create a mech-
anism which would provide the SBIC industry with access to cap-
ital on a continuous and predictable basis away from the direct
funding procedures which had been used by the Small Business
Administration since the program began in 1958 and which contin-
ued until the first public offering of debentures in September 1986.
A question at hand for your subcommittee would seem to be
whether or not your investment bankers remain confident that a
further modification to the funding mechanism can ensure the
same degree of continuity and predictability, should we have the
opportunity to proceed with future fundings under the umbrella of
a GSE rather than under the full faith and credit umbrella of the
SBA?
From our point of view, the answer is a qualified yes. More spe-
cifically, we are confident that the capital markets in which we
deal can easily absorb whatever volume of securities we might rea-
sonably expect. For example, we mentioned above that in the 10-
year history of the SBIC offerings to date, the combined total of of-
ferings sold has amounted to $1.3 billion. This represents signifi-
cantly less than 1 percent of the currently outstanding GSE debt
of some $810 billion.
We are also of the opinion that the general availability of funding
to GSE's is not particularly discriminating regarding the underlin-
ing business of that given agency. Accordingly, we do not expect
that Vickie Mae would have any delayed access to the market
while investors seek to understand the scope and nature of its busi-
ness or while they seek to see it establish a debt repayment his-
tory. In other words, in our opinion, the GSE status guarantees ac-
cess to the markets.
For many years, the GSE's pursued a debt-raising strategy that
stressed the importance of simplicity and predictability. To execute
this strategy, the agencies maintained a selling group or club of
Wall Street banks and dealers, each of which stood ready to under-
write and distribute a given agency's debt.
8
The selling groups continue to exist and remain an important
source of funding for the GSE's, but they've lost their exclusivity
in the debt-raising process.
Over the last 10 years or so, the agencies have substantially
changed their views, and a growing percentage of GSE debt is now
raised by wav of highly structured negotiated transactions, many
of which involve derivative-based solutions.
The relevance of this trend for us is that it has forced the invest-
ment community to develop the capacity to quickly evaluate more
structured programs and transactions. As a result, we believe the
characteristics that have been built into the SBIC debenture and
participating security programs providing for liberal prepayment
and acceleration rights will continue to have broad market accept-
ance.
Furthermore, should the management of Vickie Mae wish at
some time in the future to consider other funding mechanisms or
structures, it should not expect to face difficulties in continuing to
attract a broad investor base.
As a recap, we believe that the new GSE will face no practical
limitations on the amount of money available to it and the institu-
tional investor markets in which we deal are now sufficiently so-
phisticated to permit Vickie Mae the flexibility to issue a diverse
and broad range of instruments to best manage the liability side
of its balance sheet.
Vickie Mae should, however, expect that there will be a cost asso-
ciated with switching from a full faith and credit guarantee to GSE
status. The reason for this is simply that the market differentiates
between the implied U.S. Government guarantee carried by a GSE
and the irrevocable and unconditional full faith and credit guaran-
tee offered by programs with direct U.S. Government sponsorship.
It is difficult to predict at any point in time how much higher in-
terest rates would be for a GSE than a U.S. Government-sponsored
program because this differential does change due to market condi-
tions. For example, there have been brief periods during which
rates on very short-term agency debt have actually been below
rates available on comparable Treasuries. This has happened from
time to time for technical reasons.
Conversely, there have been times when the rate differential has
been relatively wide, specifically over the past 10 years where rates
paid by Agencies have been as much as 1 percent higher than the
comparable 10-year Treasury debt.
Typically when such a widening occurs, there has been some de-
gree of structural difficulty with the segment of the economy being
served by the agency and the market is looking for some evidence
of U.S. Government support.
On balance, we believe it is realistic to assume that Vickie Mae
will need to plan to incur some higher interest cost if it plans to
fund itself with obligations similar in structure to those currently
used. Specifically, we think this incremental cost could approxi-
mate one quarter of 1 percent, which has been the average dif-
ferential between Treasuries and agencies over the past 5 years.
On the other hand, Vickie Mae will also gain substantial flexibil-
ity to issue a variety of debt instruments having a range of matu-
rities. The significance of this is that the debt obligations with
shorter term maturities generally cost the borrower less than the
same type of debt obligations with longer maturities.
This simple fact will present Vickie Mae with considerable flexi-
bility to manage its liabilities in ways that can result in it actually
mitigating the impact of operating in a marginally higher interest
rate environment. Thank you, Mr. Chairman.
Mr. TORKILDSEN. Thank you very much for your testimony, Mr.
Clare.
Now we'll hear from Mr. Murray.
[Mr. Clare's statement may be found in the appendix.]
TESTIMONY OF JIM MURRAY, COUNSEL, BROWN & WOOD
Mr. Murray. Thank you, Mr. Chairman. I'm happy to be here to
testify on the legal characteristics of the Government-sponsored en-
terprises and how Vickie Mae fits into those comparable GSE's.
My background is I was General Counsel of the Federal National
Mortgage Association, Fannie Mae, from 1970 to 1981 and served
as President of Fannie Mae from 1981 to 1983. I was also on a task
force which worked on the establishment of the Student Loan Mar-
keting Association in 1971 and I represented the American Bank-
ers Association in legislation which established the Federal Agri-
cultural Mortgage Corporation, Farmer Mac, which provides a sec-
ondary market for agricultural real estate loans.
In exhibits to my statement I compared Vickie Mae to Fannie
Mae, Freddie Mac, Sallie Mae, Farmer Mac and Vickie Mae, re-
garding the various legal characteristics of the Government-spon-
sored enterprises. There are some 14 characteristics. I'd just like
to comment on 2 of those characteristics which I think are the most
important.
One is the right of the GSE to borrow from the Treasury. In that
respect I would point out that there is a provision in Section 354(c)
of H.R. 2806 which does give me some concern. It provides that in
order for the Secretary of the Treasury to, in effect, buy debentures
of Vickie Mae, that it must be pursuant to appropriation acts in ad-
vance. That particular provision is not in any of the other Govern-
ment-sponsored enterprise statutes and I think it could give some
concern to the financial market regarding that line to the Treasury.
Because the line of credit is subject to advance appropriations, it
may be in some jeopardy and would not provide the liquidity that
the other GSE's have.
The other provision which I think is very important in the Vickie
Mae statute, H.R. 2806, is the investment by banks and savings
and loans and other financial institutions in obligations of Vickie
Mae. This is a very important provision and permits Vickie Mae to
raise funds from financial institutions which will bring in substan-
tial amounts of new capital for small business investment compa-
nies.
I think there are three important characteristics that Vickie Mae
brings to small business investment companies. One is the capital
it will provide, the new capital particularly. A second characteristic
is the ability of the GSE's and the ability of Vickie Mae to adapt
to changing capital circumstances in the capital markets.
Our financial markets are changing very rapidly and the present
program within the Small Business Administration has a very dif-
10
ficult time adapting to those changing circumstances. I think as a
GSE, Vickie Mae will be able to bring a lot of flexibility that's not
present in the existing program.
Of course the last characteristic, which is very important, is the
fact that Vickie Mae will give the industry ability to manage its
own affairs. The industry, in effect, will be providing the equity
capital and it will be able to be a self-sustaining program without
need for funds from the taxpayers.
In conclusion, I would say that H.R. 2806 is very well structured.
It provides a ^ood foundation for Vickie Mae and I think it will be
an important improvement in the existing program. Thank you.
Mr. TORKILDSEN. Thank you very much, Mr. Murray.
Mr. Zegart?
[Mr. Murray's statement may be found in the appendix.]
TESTIMONY OF JOEL ZEGART, PRESIDENT, JBS & ASSOCIATES
Mr. Zegart. Thank you very much, Mr. Chairman, for the oppor-
tunity to present our testimony at this hearing on H.R. 2806.
By way of introduction, my name is Joel Zegart and I'm Presi-
dent of JBS & Associates. We're a Chicago-based loan sale advisory
and asset disposition firm. Since the inception of our firm in 1985,
we have sold nearly $3 billion in assets for Government agencies
such as the RTC, FDIC, Ginnie Mae, and HUD.
I'm here to address one topic that has not received much atten-
tion in the proposed legislation: The liquidation of defaulted SBA
guaranteed loans and failed SBIC's. Obviously, in these times of
budgetary crisis, a well conceived and effective disposition strategy
that maximizes recovery is vitally important to the U.S. taxpayer.
JBS & Associates conducted the first loan auction for the RTC
in June of 1991. We conducted several more loan auctions for the
RTC during its tenure, including the largest loan auction ever, and
that was over $700 million in assets that were sold in 2 days.
After having observed the maturing of the market for non-
performing loans, we are convinced that there will also develop an
orderly, efficient market for the loans guaranteed by the SBA. We
witnessed the tremendous investor interest that developed around
the RTC loan sales, with each loan sale attracting more and more
investors.
The investment groups that were out there that were buying in-
cluded banks, investment banking firms, small entrepreneurial
groups and other firms that sprang up very quickly to rise to this
opportunity.
Because the RTC loan sale program was conducted in an itera-
tive competitive bid format, these investors were forced to bid open-
ly against each other, and such bidding drove prices up to market
levels. This market matured and the pricing became very efficient
using this sale method.
One particular aspect of the loan auction program that I would
like to discuss is the use of computer imaging technology. We pre-
sented this information and documentation for investor review
using computer imaging technology. Having seen firsthand the
problems with investor due diligence with hard copy of loan files
— the boxes and boxes of paper, maintaining the integrity of the
files after investors have rified through the documents and some-
11
times purposely misplacing important papers to the disadvantage
of other bidders — we realized that there had to be another alter-
native for investors to do their review.
After researching the problem, we established a pilot program for
one RTC loan auction that utilize a state-of-the-art computer imag-
ing system that allowed investors to review documents on computer
work stations.
For the RTC, we scanned and indexed over 10 million pieces of
paper for investors to review on a network of up to 200 work sta-
tions. The system worked well for investors as they were able to
comfortably review documents simultaneously so that all investors
competed on an even playing field.
We have since expanded this technology using CD-ROM, so now
investors don't have to come to a central location. We just merely
put it on a CD-ROM and they can review all this vital information
right in the comfort of their own offices.
We believe that this new loan file due diligence utilizing CD-
ROM technology will greatly broaden the universe of investors not
only nationally but globally and have opportunities to review these
documents more efficiently.
We recently conducted an auction of loan portfolios for a major
Midwestern bank using CD— ROM technology and the interesting
thing, Mr. Chairman, was the fact that these loans are very com-
parable in size and nature to the product that's generated at the
SBIC level and the SBA and it met with a tremendous degree of
success and it showed us that there were investors out there that
were very interested in buying small business loans, as opposed to
the traditional single family, 1 to 4, multifamily and other real es-
tate-related product.
For the sale of SBIC's, all of the pertinent financial information,
records, reports, and all relevant operating statements on the com-
pany could be imaged and indexed so that the entire due diligence
package would be available to potential investors on CD-ROM. As
an example, for a sale that we conducted on a shopping mall in In-
dianapolis, we pioneered the use of an interactive CD-ROM, so it
was almost a virtual walk-through of the entire mall. Environ-
mental reports, financial, all the other characteristics that one
needs to look at, before they even have to set foot on the actual
physical property, were provided.
We believe that a program utilizing imaging technology to ex-
pand the universe of potential bidders and make it easier and less
costly for investors to review assets, combined with an iterative
form of competitive bidding, would provide an efficient mechanism
for liquidating SBA-guaranteed or owned assets.
Cuirently the SBA is not utilizing such a program and is gen-
erally involved in a long protracted negotiation in selling off these
assets after loan defaults and foreclosures. Unfortunately, time is
the enemy in these cases and the assets generally deteriorate over
time and lose value. Generally, the SBA would be much better off
realizing the present value of these defaulted assets through a
well-marketed competitive bid sale.
In closing, rather than being swamped with an ever-increasing
inventory of deteriorating assets, utilization of a competitive bid
sale program and outsourcing the disposition responsibility to the
12
private sector would relieve the staff of the SBA of the burden of
managing and servicing these assets and more expeditiously con-
vert these assets into revenue for the Government. Thank you.
Mr. TORKILDSEN. Thank you for your testimony, Mr. Zegart.
[Mr. Zegart's statement may be found in the appendix.]
Mr. TORKILDSEN. For a few questions now. Mr. Clare, the point
that you made about a rising cost once this would occur, do you
have any way of estimating what type of dollar increase that would
be, or would it be totally dependent on volume or would volume
probably adjust to the cost increase?
Mr. Clare. Based on our historical review of rates and if the
past is any predictor of the future, over the last 5 years the closest
proxy we came up with was a comparison of 10-year Fannie Mae
debt with 10-year Treasuries and, on average, there was a 25 basis
point or one quarter of 1 percent increase in the cost for Fannie
Mae.
The assumption I made in our testimony was that if the SBIC
industry were to use the same types of instruments to fund itself
— that is, 10-year callable, prepayable instruments — that they,
too, may find that their cost, on average, increases about one quar-
ter of 1 percent.
But then we also present Vickie Mae with considerable flexibility
to manage its debt by issuing a variety of instruments. In other
words, it can mix shorter term obligations with longer term ones,
and that combination of liability management could go a long way
to perhaps totally offset the increase in cost it would otherwise
incur.
Mr. TORKILDSEN. So, what you're saying is that it's important to
know there will be an increase; however, the increased cost is not
going to be so significant that it's going to dislocate the market or
anything like that.
Mr. Clare. No, not at all. I think the evidence that the existing
GSE's have $810 billion of debt outstanding, which they raised very
efficiently, is a clear indication that those segments of the economy
are well served by the GSE mechanism.
Mr. TORKILDSEN. Would any of the witnesses like to offer an esti-
mate that once privatized, what type of capital or debt you would
see Vickie Mae raising? Obviously, it's some speculation, but any
idea what type of range any of you would expect it to be in?
Mr. Clare. Well, it would very much depend, Mr. Chairman, on
what interest rates looked like at the time. For example, typically
short-term interest rates cost less than longer-term interest rates.
That's called a positive yield curve.
But there are times when short-term interest rates can be high-
er, and by a substantial amount, than long-term. Such inversions
usually come before economic slowdowns in the country. If you look
back historically, there have been such inversions prior to each eco-
nomic slowdown we've experienced.
In periods of normal growth and expansion, however, you would
expect that Vickie Mae would have the option of using shorter-term
interest rates to fund portions of its debt load and therefore reduce
its overall debt burden.
Right now the program comprehends a matched funding, which
is a very inflexible approach to raising money, where the money
13
that's raised is serviced by the debt in the pools of debentures and
it's simply a pass-through, so there's no ability to manage liabilities
in an efficient way.
Mr. Dunbar. Just to expand on that, Mr. Chairman, as Mr.
Clare said, it's impossible to speculate on the exact size that the
program would grow to but the industry attempted to make an es-
timate and based on the size of the industry today and an assumed
growth of roughly 15 new participating securities, SBIC's and 15
new debenture-using SBIC's per year over the next 4 years, the
program grew to a total capital size of a little over $3 billion,
roughly two-thirds of that being participating securities and about
a billion dollars in debenture securities. That's one rough estimate.
Mr. TORKILDSEN. Another question, Mr. Dunbar. You mentioned
about the need for patient capital. From your perspective, is Vickie
Mae going to be able to meet that need more than the private sec-
tor can right now? Is venture capital too impatient, especially for
small- and medium-size concerns?
Mr. Dunbar. We do believe that Vickie Mae would address that
issue. The problem with the venture capital industry today is that
the venture capital industry is consolidating into fewer and fewer
very large funds and it is not economical for those large funds —
typically $1 or $2 billion or more dollars under management — it
is not economical for them to do $500,000 investments, $1 million
investments, which are what most small businesses need.
In addition, those large funds tends to be concentrated in major
cities and more and more they're investing in overseas companies,
where they foresee larger potential returns.
So we believe there is a significant need for long-term patient
capital for smaller businesses, focussed on U.S. businesses and fo-
cussed on geographically diverse businesses, and we believe that
only through creation of Vickie Mae can the industry really grow
to its full potential and address that need.
Mr. TORKILDSEN. Mr. RafFerty, while clearly there's a savings to
the taxpayers in adopting this change, do you see advantages for
investors, as well, under this new umbrella?
Mr. Rafferty. SBIC's and the people who provide us capital?
Mr. TORKILDSEN. Yes.
Mr. Rafferty. Clearly this is the case. In my testimony, I tried
to state the power of the combination of a certain flow of capital
into the sector and the effect that has on returns, and it is a return
game from the investor point of view. But I believe that the model
and the history of this industry support the fact that if properly
capitalized, which goes to the stable certainty of flow of funds, and
professionally managed, there's real predictability to the returns.
When that is demonstrated, the investors continue to have a
good reason, their only reason, for providing support to this seg-
ment, the SBIC's.
Mr. TORKILDSEN. Thank you.
For Mr. Zegart, could you go into greater detail on how similar
the liquidations of the SBIC portfolio would be to other Govern-
ment agencies and would you expect that the additional amount
collected by Vickie Mae for defaulted loans and SBIC's would cover
the 10 percent fee or so that would be required as part of these col-
lection efforts?
14
Mr. Zegart. You mentioned 10 percent, Mr. Chairman. What is
that again?
Mr. ToRKiLDSEN. That's just an arbitrary number. Whatever the
cost in collection would be, and obviously that percentage would
vary, but would you expect we could generate whatever the cost of
collection would be?
Mr. Zegart. Absolutely, Mr. Chairman. I mean, if you look at de-
faulted loans, they're not like fine wine. They don't improve with
age. Generally speaking, we have found historically that by acting
quickly and moving these credits to markets where there's more ei-
ficiencies and better economies of scale, that it will serve the tax-
payer much more efficiently, as evidenced by what the RTC was
domg and currently the FDIC and HUD.
Mr. TORKILDSEN. Thank you. That pretty much covers my ques-
tions. Would any of you like to offer any final comments or com-
ment on any other statements that were made?
[No response.]
Mr. TORKILDSEN. With that, I thank you all for your testimony
and this hearing is adjourned.
[The subcommittee was adjourned at 10:55 a.m., subject to the
call of the chair.]
15
APPENDIX
JAN MEYERS, Kansas JOHN J. UFALCE, New York
CongreBS of the lEnited States
ftoust of KcprestntatioEB
mtti Congress
Committee on ^m\\ business
2561 'Raijbum ftonsc ©Rice Buildlnfl
Walimgnni, B£ 2i)5n-«iii
OPENING STATEMENT
PETER G. TORKILDSEN
CHAIRMAN. GOVERNMENT PROGRAMS SUBCOMMITTEE
HOUSE COMMITTEE ON SMALL BUSINESS
HR 2806
VENTURE CAPITAL MARKETING ASSOCIATION
CHARTER ACT
Good afternoon. As Chairman of the Small Business Subcommittee on
Government Programs it is a pleasure to welcome our guests today. The
purpose of this hearing is to discuss HR 2806, the "Venture Capital
Marketing Association Charter Act" [VICKIE MAE], which I introduced
during the first session of this Congress, and the privatization model that lead
to the legislation before us today.
Privatization has been the subject of much debate in this Congress and
in previous Congresses. It is important that we recognize that there are
16
functions that the Federal government now performs that would be better off
in the hands of the private sector. It is true that we have to be selective in our
efforts to privatize government functions, but I believe that this is one area
where privatization ultimately makes sense.
The current SBIC program is a unique partnership between the private
sector and the Federal government. SBICs are capitalized with private funds
and managed by skilled professionals in the venture capital field who make
their investment decisions without overt interference from government. The
US Small Business Administration currently oversees SBICs. Although the
program is sound there is still room to grow and improve.
The model to privatize the SBIC program brings that opportunity to
grow. The proposal to privatize creates a government-sponsored enterprise
(GSE), named VICKIE MAE, that would be statutorily charted by Congress
to act as a capital bank for the SBIC industry. The new corporation would
replace the SBIC program functions now performed by SBA. It would create
a dependable flow of ftinds to SBICs at reasonable costs and finally, it would
17
provide an improved operating environment for SBICs to conduct business.
But above all, the privatized system would give small business increased
access to venture capital markets, markets that are often closed to them.
Clearly, through privatization, our goal is to give small business more
access to the capital market, but this legislation specifically focuses on taking
the existing SBIC program and transforming it into a new, off-budget,
government-sponsored enterprise. This enterprise has the potential to save
taxpayers an estimated $187 million dollars over 5 years. It is necessary to
take steps in this direction as the Congress works to balance the Federal
budget.
I am interested in hearing the testimony of our witnesses today on a
variety of issues including liquidation, the legal characteristics of creating
GSE's, the issue of selling bonds on the open market and the markets'
acceptance of these securities, and finally the comments of a community
SBIC representative.
18
With that, I will conclude my statement and yield to my colleague, Mr.
Poshard, for any statement he may wish to make at this time.
19
HOUSE SUBCOMMITTEE ON GOVERNMENT PROGRAMS
HEARING ON H.R. 2806, THE VENTURE CAPITAL MARKETING ASSOCIATION
CHARTER ACT
Opening Statement of Congressman Glenn Poshard
April 18, 1986
Mr. Chairman, I am glad to be here this morning to learn more about H.R. 2806 and
the prospects for creating a greater pool of capital for developing industries. Much of our
work this Congress in this Subcommittee and the full Committee has been geared to helping
spur innovation and nurture ideas that otherwise would not get developed. The STTR and
SBIR programs are examples of this commitment, and I certainly welcome any attempt in
this direction.
I do have some questions about this legislation that I am sure will be addressed today.
The full Committee has tentatively scheduled a hearing on venture capital for May as a part
of a series of hearings on increasing access to capital. How does this bill fit into that overall
scheme? Since the current SBIC program is producing results, will this initiative perform
markedly better? Similar legislation has been proposed in the past, why is now the time to
change?
Mr. Speaker, thank you for your concern for the health of our nation's small
businesses and your leadership on this issue. I would also like to extend a warm welcome to
our distinguished panel, I appreciate your time and expertise and look forward to your
testimony on this topic.
20
Chase Securities Inc.
270 Park Avenue
New York, NY 10017
212-834-5160
Re: H.R. 2806
Venture Capital Marketing Association (Vickie Mae)
104"^ Congress 1" Session
HOUSE COMMITTEE ON SMALL BUSINESS
THURSDAY, APRIL 18, 1996
10:00 AM
ROOM 2359
RAYBURN BUILDING
WASHINGTON, DC
COMMENTS BY: MICHAEL CLARE
MA NA GING DIRECTOR
CHASE SECURITIES INC.
GOOD MORNING MR. CHAIRMAN. MY NAME IS MICHAEL CLARE.
I AM A MANAGING DIRECTOR AT CHASE SECURITIES INC. IN
NEW YORK. IT IS A PLEASURE FOR ME TO BE AFFORDED THIS
OPPORTUNITY TO SHARE MY VIEWS WITH YOUR MOST
DISTINGUISHED COMMITTEE.
I HAVE BEEN INVOLVED IN THE SBIC PROGRAM IN A VARIETY
OF ROLES SINCE 1985. INITIALLY, I WAS INVITED TO BECOME
PART OF THE INVESTMENT BANKING ADVISORY GROUP THAT
DESIGNED THE MECHANISM THAT WE CONTINUE TO USE TODAY
FOR THE QUARTERLY SALES OF SBA-GUARANTEED
DEBENTURES.
21
SUBSEQUENTLY, I WAS INVITED TO HELP CONSTRUCT A
PROGRAM TO LAUNCH PARTICIPATING SECURITIES. I ALSO WAS
ASKED TO HELP OUT ON THE LEGISLATIVE INITIATIVES COSBI
AND NOW VICKIE MAE.
FROM THE INCEPTION OF THESE TWO PROGRAMS, MY
COLLEAGUES AND I HAVE BEEN DIRECTLY INVOLVED IN
BRINING TO THE SECURITIES MARKETS 37 SEPARATE
DEBENTURE OFFERINGS WORTH SI. 023 BILLION AND 5
SEPARATE PARTICIPATING SECURITIES OFFERINGS WORTH
S310.33 MILLION.
THE INTENT OF THESE PROGRAMS WAS (AND REMAINS) TO
CREATE A MECHANISM WHICH WOULD PROVIDE THE SBIC
INDUSTRY WITH ACCESS CAPITAL ON A CONTINUOUS AND
PREDICTABLE BASIS AWAY FROM THE DIRECT FUNDING
PROCEDURE WHICH HAD BEEN USED BY THE US SMALL
BUSINESS ADMINISTRATION SINCE THE PROGRAM BEGAN IN
1958 AND WHICH CONTINUED UNTIL OUR FIRST PUBLIC
DEBENTURE OFFERING IN SEPTEMBER 1986.
A QUESTION AT HAND FOR YOUR COMMITTEE WOULD SEEM TO
BE WHETHER OR NOT YOUR INVESTMENT BANKERS REMAIN
CONFIDENT THAT A FURTHER MODIFICATION TO THE FUNDING
MECHANISM CAN ENSURE THE SAME DEGREE OF CONTINUITY
AND PREDICTABILITY SHOULD WE HAVE OPPORTUNITY TO
PROCEED WITH FUTURE FUNDINGS UNDER THE UMBRELLA OF A
GSE CALLED VICKIE MAE RATHER THAN UNDER THE FULL FAITH
AND CREDIT GUARANTEE OF THE SBA?
FROM OUR POINT OF VIEW, THE ANSWER IS A QUALIFIED YES.
MORE SPECIFICALLY, WE ARE MOST CONFIDENT THAT THE
CAPITAL MARKETS IN WHICH WE DEAL CAN EASILY ABSORB
WHATEVER VOLUME OF SECURITIES WE MIGHT REASONABLY
EXPECT. FOR EXAMPLE, WE MENTIONED ABOVE THAT IN THE
TEN YEAR HISTORY OF SBIC OFFERINGS TO DATE, THE
22
COMBINED TOTAL OF SBIC OFFERINGS SOLD HAS AMOUNTED
TO $L33 BILLION.
THIS REPRESENTS SIGNIFICANTLY LESS THAN 1% OF THE
CURRENTLY OUTSTANDING GSE DEBT OF SOME $810 BILLION.
WE ALSO ARE OF THE OPINION THAT THE GENERAL
AVAILABILITY OF FUNDING TO GSEs IS NOT PARTICULARLY
DISCRIMINATING REGARDING THE UNDERLYING BUSINESS OF A
GIVEN AGENCY. ACCORDINGLY, WE DO NOT EXPECT THAT
VICKIE MAE WOULD HAVE ANY DELAYED ACCESS TO THE
MARKET WHILE INVESTORS SEEK TO UNDERSTAND THE SCOPE
AND NATURE OF ITS BUSINESS OR WHILE THEY SEEK TO SEE IT
ESTABLISH A DEBT REPAYMENT HISTORY. IN OTHER WORDS, IT
IS OUR OPINION THAT GSE STATUS ENSURES MARKET ACCESS.
FOR MANY YEARS THE GSEs PURSUED A DEBT RAISING
STRATEGY THAT STRESSED THE IMPORTANCE OF SIMPLICITY
AND PREDICTABILITY. TO EXECUTE THIS STRATEGY THE
AGENCIES MAINTAINED A SELLING GROUP OR CLUB OF WALL
STREET BANKS AND DEALERS EACH OF WHICH STOOD READY
TO UNDERWRITE AND DISTRIBUTE A GIVEN AGENCY'S DEBT AS
ESTABLISHED IN A SCHEDULE WELL IN ADVANCE OF THE
OFFERING DATE. THESE SELLING GROUPS CONTINUE TO EXIST
AND REMAIN AN IMPORTANT SOURCE OF FUNDING FOR THE
GSEs— BUT, THEY HAVE LOST THEIR EXCLUSIVITY IN THE DEBT
RAISING PROCESS.
OVER THE LAST TEN YEARS OR SO, THE AGENCIES HAVE
SUBSTANTIALLY CHANGED THEIR VIEWS AND A GROWING
PERCENTAGE OF GSE DEBT IS NOW RAISED BY WAY OF HIGHLY
STRUCTURED. NEGOTIATED TRANSACTIONS— MANY OF WHICH
INVOLVE DERIVATIVE-BASED SOLUTIONS. THE RELEVANCE OF
THIS TREND FOR US IS THAT IT HAS FORCED THE INVESTMENT
COMMUNITY TO DEVELOP THE CAPACITY TO QUICKLY
EVALUATE MORE STRUCTURED PROGRAMS AND
TRANSACTIONS.
23
AS A RESULT, WE BELIEVE THAT THE CHARACTERISTICS THAT
HAVE BEEN BUILT INTO THE SBIC DEBENTURE AND
PARTICIPATING SECURITY PROGRAMS PROVIDING FOR LIBERAL
PREPAYMENT AND ACCELERATION RIGHTS WILL CONTINUE TO
HAVE BROAD MARKET ACCEPTANCE. FURTHERMORE, SHOULD
THE MANAGEMENT OF VICKIE MAE WISH AT SOME TIME IN THE
FUTURE TO CONSIDER OTHER FUNDING MECHANISMS OR
STRUCTURES, IT SHOULD NOT EXPECT TO FACE DIFFICULTIES IN
CONTINUING TO ATTRACT A BROAD INVESTOR BASE.
AS A RECAP, WE ARE OF THE OPINION THAT A NEW GSE WILL
FACE NO PRACTICAL LIMITATIONS ON THE AMOUNT OF MONEY
AVAILABLE TO IT AND THAT THE INSTITUTIONAL INVESTOR
MARKETS IN WHICH WE DEAL ARE NOW SUFFICIENTLY
SOPHISTICATED TO PERMIT VICKIE MAE THE FLEXIBILITY TO
ISSUE A DIVERSE AND BROAD RANGE OF INSTRUMENTS TO
BEST MANGE THE LIABILITY SIDE OF ITS BALANCE SHEET.
VICKIE MAE SHOULD, HOWEVER, EXPECT THAT THERE WILL BE
A COST ASSOCIATED WITH SWITCHING FROM A FULL FAITH AND
CREDIT GUARANTEE AS IS CURRENTLY PROVIDED BY THE
SMALL BUSINESS ADMINISTRATION TO GSE STATUS. THIS COST
WILL MANIFEST ITSELF IN THE FORM OF HIGHER INTEREST
RATES ON THE DEBT OBLIGATIONS WHICH IT ISSUES. THE
REASON FOR THIS IS SIMPLY THAT THE MARKET
DIFFERENTIATES BETWEEN THE IMPLIED US GOVERNMENT
GUARANTEE CARRIED BY A GSE AND THE IRREVOCABLE AND
UNCONDITIONAL FULL FAITH AND CREDIT GUARANTEE
OFFERED BY PROGRAMS WITH DIRECT US GOVERNMENT
SPONSORSHIP.
IT IS DIFFICLTLT TO PREDICT AT ANY GIVEN POINT IN TIME HOW
MUCH HIGHER INTEREST RATES WOULD BE FOR A GSE THAN A
US GOVERNMENT-SPONSORED PROGRAM BECAUSE THIS
DIFFERENTIAL DOES CHANGE DUE TO MARKET CONDITIONS.
FOR EXAMPLE. THERE HAVE EVEN BEEN BRIEF PERIODS DURING
WHICH RATES ON VERY SHORT TERM GSE DEBT HA\T
24
ACTUALLY BEEN BELOW RATES AVAILABLE ON COMPARABLE
TREASURY BILLS. THIS HAS HAPPENED FROM TIME TO TIME
FOR TECHNICAL REASONS USUALLY HAVING TO DO WITH A
LACK OF SUPPLY OF TREASURY BILLS IN THE MARKET
MATURING ON POPULAR DATES SUCH AS WHEN TAX PAYMENTS
ARE DUE.
CONVERSELY, THERE HAVE BEEN TIMES WHEN THE RATE
DIFFERENTIAL HAS BEEN RELATIVELY WIDE. SPECIFICALLY,
OVER THE PAST TEN YEARS, THE RATES PAID BY GSEs HAVE
BEEN AS MUCH AS — % HIGHER THAN COMPARABLE 10 YEAR US
TREASURY DEBT. TYPICALLY, WHEN SUCH WIDENING OCCURS
THERE HAS BEEN EVIDENCE OF SOME DEGREE OF STRUCTURAL
DIFFICULTY WITH THE SEGMENT OF THE ECONOMY BEING
SERVED BY THE GSE AND THE MARKET IS LOOKING FOR SOME
EVIDENCE OF THE US GOVERNMENT'S CONTINUING AND
ACTIVE SUPPORT.
ON BALANCE, WE BELIEVE IS REALISTIC TO ASSUME THAT
VICKIE MAE WILL NEED TO PLAN TO INCUR SOME HIGHER
INTEREST COSTS IF IT PLANS TO FUND ITSELF WITH
OBLIGATIONS SIMILAR IN STRUCTURE TO THOSE CURRENTLY
USED. ON THE OTHER HAND. VICKIE MAE WILL ALSO GAIN
SUBSTANTIAL FLEXIBILITY TO ISSUE A VARIETY OF DEBT
INSTRUMENTS HAVING A RANGE OF MATURITIES.
THE SIGNIFICANCE OF THIS IS THAT DEBT OBLIGATIONS WITH
SHORT-TERM MATURITIES GENERALLY COST THE BORROWER
LESS THAN THE SAME TYPE OF DEBT OBLIGATIONS WITH
LONGER MATURITIES. FOR EXAMPLE, ONE YEAR TREASURIES
CURRENTLY COST THE U.S. GOVERNMENT 1% LESS THAN THE
COST OF A 10 YEAR OBLIGATION. THIS SIMPLE FACT WILL
PRESENT VICKIE MAE WITH CONSIDERABLE FLEXIBILITY TO
MANAGE ITS LIABILITIES IN WAYS THAT CAN RESULT IN IT
ACTUALLY MITIGATING THE IMPACT OF OPERATING IN A
MARGINALLY HIGHER INTEREST RATE ENVIRONMENT.
25
I WOULD HOPE THAT THE COMMITTEE HAS FOUND MY
OBSERVATIONS USEFUL AND RELEVANT. I WOULD BE MOST
PLEASED TO ANSWER ANY QUESTIONS YOU MAY HAVE NOW OR
TO RESPOND TO ANY QUESTIONS IN WRITING WHICH THE
COMMITTEE MAY HAVE AT SOME LATER DATE. AGAIN THANK
YOU VERY MUCH FOR THIS OPPORTUNITY.
26
(sjuiod sisEq)
27
N A S B I C
NATIONAL ASSOCIATION W SMALL BUSINESS INVESTMENT COMFANJES
1 199 N. Fairfax Street • Suile 200 • Alexaiwha, VA 22314 • Tel: (703) 6«3-l60l • FAX: (7031 683-1*05
■ lUHVEy CKANAT
Swiing Conunfltul Capita], Inc r^ a
G»,teLm Stat^nent
V«fOiainnBB
• CW DICK
Ptomct Venhires. LP
!^r of
• rAMK f OTWNNELL
CdpiUl hit Busmeu. ini
St Louis, MO
WUMmh F. Dvnbar
National Association
of
SmaH Business Inv^lment Companies
• WILLIAM F- DUNBAR
A)li.-J '"jpital Advisers, !nc
Wa^hir', -r^ DC
before the
Charlone, M>
WILUAM ). HARPER
Fmi Commerce CapUl, Inc
DrviormLLMAN CouMmttee on SmaH Buaness
PNC Equitv Maiugemmt Coip
Pittsburgh PA
PAULM.KELLEY
Zero Su^e Capital
SubconuMttee on Government Programs
1UCHARD c Kunx, United States House rf RepresenUti ves
Cambndjje. MA
RICHARD CK
Rr^t \ew England Captal. LP
HanioTd CT
PRANK R-KUNE
Kline H^wkes Caliiomu SBIC. L P
Li» Angeles CA
THOMAS E. LOEHR
fourth \entufB Investment Group. Inc
RFE InvBtmeni Partnm
* RAYMOND R. RAFFERTY, )R.
Mendiao Verture Partners
Radnor PA
WILUAM REISLER
Kansas Ciiv Etfuitv Partiters
Praine Village. kS
)OHN C WEISS 111
iihemCapiiaLLP
timore. MD
.HOMASWESTMOOK
April 18, 1996
Minneapolis, M\
MAnHiwLwnn
Marwit Capital. LLC
Newport BeKh. CA
' litnlmCommtttr
28
Mr. Chairman and members of the Subcommittee:
I appreciate the opportunity to be here today on behalf of the National Association of Small
Business Investment Companies (NASBIC), the association representing the SBIC industry.
In my professional capacity I am president of Washington, DC-based Allied Capital Corporation
n and of Allied Investment Corporation II, a wholly owned subsidiary which is an SBIC with
$10 million in funded capital. I also serve as executive vice president of all other funds
managed by Allied Capital Advisers, including a second SBIC, the oldest SBIC in the country,
and an SSBIC.
We want to begin by commending Chairman Torkildsen for sponsoring H.R. 2806, the
"Venture Capital Marketing Association Charter Act," and for holding this hearing today. We
believe that the demonstrated lack of sufficient long-term, patient capital for America's small
businesses and the circumstances relating to today's SBIC program make creation of "Vickie
Mae" in the near future a winning path for all involved. These include U.S. taxpayers who
want their Government to ensure a flow of capital to small businesses pursuant to a safe and
cost-effective program, private investors who are willing to provide both initial and leverage
capital to SBICs if they believe the program has stability and reliability, and the small
businesses that will use the capital to create tomorrow's jobs and the new technologies
necessary to ensure our continued competitive position in an increasingly global economy.
The proposed legislation would make Vickie Mae a Government Sponsored Enterprise (GSE),
perhaps the best form of parmership between the Government and the private sector to advance
critical public policy objectives such as those represented by the SBIC program: to provide
growth, modernization and expansion capital for small U.S. companies. As the February 28,
1996, House Small Business Committee hearing on access to capital underscored, U.S. small
businesses still have great difficulty raising the long-term patient capital they need to create the
jobs and technologies that are the foundation of our country. Increasingly, venture capital is
being consolidated in very large funds, making investments in the $250,000 to $3 million range
impractical and uneconomical for large fund managers. Also, a larger percentage of U.S.
venture capital than ever before is being invested overseas in non-U. S. companies. Because of
the realities of the global economy, a large percentage of these foreign companies will compete
with the same small U.S. companies that find it difficult to raise their required capital bases.
The SBIC program, greatly improved by virtue of legislation in 1992, has the potential to
balance that equation.
Others will testify today on the legal attributes and the market acceptance of securities to be
issued by Vickie Mae to fund the transferred SBIC program. What NASBIC would like to
emphasize today are the advantages that will accrue to the Government and the small businesses
that are the beneficiaries of the SBIC program if Vickie Mae is created.
Before I begin, I would like to submit two items for the record. As you know, in June of 1995,
we prepared report titled "A Proposal to Privatize the SBIC Program," and we are submitting
that report and its supporting economic model with this testimony. Also submitted is the
testimony I gave before the Senate Small Business Committee on July 13, 1995, on that
proposal. The report and my previous testimony deal with the complete range of issues
involved in the Vickie Mae proposal.
I would now like to discuss what we believe are the four advantages associated with the
proposed legislation. They are listed below.
• Creation of Vickie Mae will make the SBIC program a private sector
enterprise, eliminate Government's direct management and guarantor status,
and continue the path towards possible privatization in the future.
29
Creation of Vickie Mae will allow the SBIC program to reach its full
potential in providing long-term, patient capital to U.S. small businesses.
Creation of Vickie Mae will increase the safety and soundness of the SBIC
program, thus minimizing risk to the Government.
Creation of Vickie Mae will reduce the size and cost of Government even as
financial assistance to small business is increased.
Private Sector Enterprise
Vickie Mae can be seen as the next logical step in a what has been a very successful program for
meeting critical capital needs of U.S. small businesses that private capital markets do not meet.
The SBIC program was first established as a directly funded, government-managed program.
At present, the SBIC program, still managed by the Government, operates on the strength of the
Government's explicit guarantee of securities sold in the private capital markets. The proposed
legislation would advance the model by requiring the private sector to first invest in the creation
of Vickie Mae, assume all operating responsibility for the for-profit entity, and raise funds in the
capital markets on the strength of the Government's implicit guarantee of issued securities. This
is the logical next step in a progression that may lead eventually to the full privatization of the
program by eliminating the need for the Government's implicit guarantee. This would be
considered the ultimate success because it would mean Govemment would have helped create a
successful, fully private sector enterprise, where one had not existed before, and address a
public need. We are not to that stage yet, but creating Vickie Mae is the next step.
The private sector acceptance of Vickie Mae cannot be over emphasized. For Vickie Mae to
become a reality it is not enough that Congress enact enabling legislation. That is the first step.
For Vickie Mae to take flight, private capitalization of the corporation is required. The amount
projected in our model is $20 million, a significant sum. That capital is at risk from the very
beginning of Vickie Mae and will not be invested lightly. It is private capital over and above
that which SBICs raise for their own operations. It is private capital upon which its investors
expect a return. It is one thing to identify a public policy goal; it is quite another to create a
program which industry will embrace with capital and the managerial expertise and diligence
necessary to profit from the investment. We believe Vickie Mae will meet this test.
Full Potential
The SBIC program will not reach its full potential without the creation of Vickie Mae. There
has been significant growth in the program in the past two years, but restricted program funding
levels and restrictive pressures on SBA's management resources hold the program back. As
Congress moves to reduce the size of Govemment in terms of dollars and personnel, the newly
improved SBIC program is caught in the middle.
The debenture program is now short an estimated $300 million in terms of meeting the leverage
needs of existing debenture SBICs alone. Existing SBICs and those waiting to be licensed are
there because of their belief that the Govemment will live up to expectations. Leverage SBICs
are formed in reliance on the availability of maximum leverage. The business plans they use to
attract their private capital bases project the use of that leverage. If the capital necessary to fully
leverage SBICs is not available (as is now the case with debenture funding), or if it is seen as
uncertain (as the annual authorization, appropriations, and rescission cycles are now seen),
private investors will lose interest and the SBIC program will fail to reach its full potential.
0/1_l -Jl r\
30
Furthermore, the full potential of the program can only be realized if adequate management
resources and efficiencies are applied to the program. As Congress moves to reduce the size of
Government in terms of both dollars and personnel, the pressures on the SBA's management
group will grow. Licensing now takes from six to nine months, a disincentive in itself for those
who might be new program licensees. Handling of the liquidation portfolio is suspect,
tarnishing the program perhaps unnecessarily. Without the profit motivation of the private
sector and subject to the sometimes counterproductive restraints of the annual budget process, it
is not surprising that many list Government management of the program (as distinct from
Government oversight) as a further impediment to the SBIC program reaching its full potential.
Vickie Mae would take the uncertainty out of the program, both in terms of capital availability
and program management. Subject always to regulatory requirements and Government
oversight, market forces would dictate the size of the program. This would improve the ability
of the program to attract sophisticated private capital, capital which always has alternative
investment opportunities available to it. Vickie Mae would allow the SBIC program to reach its
full potential.
That full potential is considerable. In 1992, Congress created the platform for dramatic growth
in the SBIC program by improving the enabling legislation. In the two years since the
regulations implementing the legislation became effective, 57 new SBICs have been licensed by
SBA and have brought approximately $834 million in new private risk capital into the program
to benefit small U.S. companies. That is more than had been invested in the SBIC program by
the private sector in the previous 15 years.
However, the newly licensed SBICs represent only a part of the story. At present, 76
additional SBIC license applications are pending at the SBA. If all were established in
accordance with their applications and leveraged at two times private capital, over $2.6 billion in
new capital would be available to small U.S. companies. To take a smaller subset, of the 76
pending applicants, 43 have already received commitments from their private investors for $424
million and need only to be licensed to start investing in small U.S. companies. If this smaller
group were licensed and leveraged, approximately $ 1 .2 billion in new capitfil would be available
for small business investments. Depending on the new capital figure used, and projecting zn
average investment of $500,000, somewhere between 2,400 and 5,200 additional, worthy
small business might be financed.
NASBIC does not suggest that all pending licensees are qualified and should be licensed, but it
is a measure of the new potential for the SBIC program that so many are lined up waiting to
participate. The improved SBIC program is poised to make a dramatic contribution to
America's business base if it can reach its full potential. Vickie Mae can provide the structure
for that contribution. Our model projects 321 active SBICs by 2002. We are well on our way
to reaching those numbers if the current funding and management issue can be addressed.
Safety and Soundness
Chartering Vickie Mae and allowing the SBIC program to grow to meet the real market demand
will improve its safety and soundness, thus reducing the risk that the Government will ever be
called on its implicit guarantee of securities sold by Vickie Mae. The program already provides
a large measure of safety for the Government and, ultimately, U.S. taxpayers. SBICs must
lose 100 percent of their private capital before the Government is at risk and, in the participating
securities program, the losses must then exceed any profits the Government had received from
those securities. These underlying assets are the most important safety net for the program, just
as the underlying value of mortgaged real estate is the safety net for the mortgage-oriented
GSEs. Additionally, Government oversight exists in the current program and will be continued
31
under Vickie Mae. A Board of Directors, of which five will be appointed by the President, will
be responsible for policy direction of Vickie Mae. These are substantial built-in safeguards.
However, the major part of the safety and soundness improvement will be related to the actual
growth in the program. The reasons for this are threefold: ( 1 ) fully leveraging any single SBIC
reduces risk with respect to that SBIC; (2) allowing the program to grow larger will spread the
risk over a larger base; and (3) Vickie Mae as an entity must fund losses to the extent of its
capitalization.
First, being able to draw maximum leverage capital is an important safety feature for leverage
SBICs. Their business plans and investment strategies are based on the availability of that
capital. Thus, the size of individual investments and the total number of investments to be held
in a fully invested portfolio are directly related to the expected maximum capital. If it is not
available, portfolio diversification, which is a primary factor in reducing risk, is adversely
affected. The current funding situation facing the debenture program underscores the problem.
Even if the program grows to $225 million in FY'97 (as proposed in the President's budget), it
will still fall an estimated $ 100 million short of meeting the demand for leverage by current
licensees alone. Not only can this introduce more risk into the program as discussed above, but
it will serve as a disincentive for new capital and highly talented managers to seek admission to
the SBIC program.
Second, failing to allow the program to grow to meet reasonable demand, always in concert
with strict licensing criteria and rigorous oversight, will keep the risk higher than it need be.
Just as diversification in a single fund spreads risk within the portfolio, so too, the larger the
total program, up to a reasonable demand, the broader the base upon which total program risk is
spread. While any given fund can lose money, it is highly unlikely that a broad-based SBIC
industry, as a microcosm of the total venture capital industry, will lose money. Not only is
private capital at risk first, but the experience of the venture industry as a whole comes into
play. In a study of the venture capital industry from 1976 to 1989, there was not one year in
which the industry as a whole lost money. See Investment Benchmarks Report: Venture
Capital. Venture Economics Investor Services (1994). It should be noted that the return
assumptions used in the Vickie Mae model are more conservative than those found in the
Venture Economics' study. With private capital at risk first and the substantially higher
qualifications required of SBIC managers since 1994, it all the more likely that this will be the
result for the SBIC industry in the years to come.
Third, Vickie Mae will be the insurer of first resort to the extent of its capital, not the
Government. This is a major, additional protective element for the Government. Starting with
an initial capitalization of $20 million, that capital is projected to grow to nearly $500 million
within ten years. This added buffer makes it even less likely that the Government will be called
upon its implicit guarantee of Vickie Mae's securities. In this latter regard, it is important to
note that five members of the Board of Directors of Vickie Mae will be appointed by the
President.
The Size and Cost of Government is Reduced
People differ when projecting savings that would accrue to the Govemment upon the creation of
Vickie Mae. In our model, we used the figure of $250 million over a period of five years. The
major savings will come with respect to the elimination of appropriated funds — ^$40.5 million in
FY'96. Depending on projected program levels and various performance assumptions, the
annual appropriations savings can change.
Additional savings and size reduction in Govemment will be realized because the need for
Govemment personnel other than oversight personnel will be eliminated. This is particularly
32
important. If the program is allowed to grow to meet demand, more management resources
may be required. Creating Vickie Mae will shrink the size of Government while creating job
opportunities in the private sector.
Not all Government jobs will be eliminated since the SB A will retain a rightful oversight
function. However, the result will be the proper allocation of overhead costs between the
private and public sectors. The private sector will be responsible for all operational management
costs while the Government retains responsibility for traditional and accepted oversight costs.
In conclusion, creating Vickie Mae will allow the SBIC program, one of our country's most
successful programs, to reach its full potential in helping America's entrepreneurs create the
jobs and technologies that are the foundation of America's greatness. At the same time, it will
(1) provide a logical context within which eventual full privatization might be accomplished, (2)
increase the safety and soundness of the program by removing uncertainty and artificial
impediments to market forces and installing the private sector as the insurer of first resort, and
(3) reduce the size of Government by properly allocating management and oversight
responsibility between the Government and the private sectors. Vickie Mae will permit the SBIC
program to meet its critical public policy goal through leverage of private sector leadership,
capital, and management expertise. As a GSE, Vickie Mae will represent the best in a
partnership between Government and the private sector.
Thank you for your time and attention. I will be pleased to answer any questions you might
have.
33
N A S B IC
NATIONAL ASSOCUTION OF SMALL BUSINESS INVESTMENT COMPANIES
1 199 N. Fairfax Street • Swte 200 • Alexandria, VA 22314 • Tel: (703) 683-1601 • FAX; (703) 683-1605
Ki&bingUR. DC
FETIRF-McNnSH
• DAVID M(L HULMAN
PNC Equny Manigoneni Corp
PmsbiB^PA
• lEFFlTY C WALKUt
No. tork. \y
• HAJtVTYCR
CrwlN«k.NY
80AJU) or GOVERNORS
mOMAS J. ADAMK
Preouer Vcmirt Opi&l Corp
Biion Rflugt. LA
KSVn C AUR£CKT
RFE CipmJ Pamm. LP
Nn.CaBun.CT
NICHOLAS t. BWlOfY
SBIC Panncv LP
EOWAJtD C BROWN
hUnkn tmhoff Cspial PiTtncn
[>nwf.CO
DAVID D.OtOU
^4(du/Comslun)at)ans Partncn
Boston. MA
QurioOtNC
H WAYNl HMIEMAN
BiiK One Vennar Corp
MiKmk«c W1
K£r™R.FOX
Emw Vamire Loides. LP-
\«. York. NY
wniiAM ]. HARFCR
Rrs CoouB0n Ciptollnc
Nv^Orioi&LA
■ SLXUmi B. KRISCUNAS
Banc Om Capttil Panned Corp
Dallas. TX
THOMAS LLOEHR
Chari«sa>n,WV
• JAMES F. 0TX)SNEli
Opita] For Busncss. be
St.LoaB.MO
* JAMES A. rASSONS
RFE bvetawni Pvmm
New Canaan. CT
• RAYMOND R. RAfFEKTY, JR.
Mcndian Vetmrc PiTtnes
Radmr.PA
WILUAM REISLIX
Kansas Gtv Eqiafv Pannos
Prune VabgcKS
* HOWARD F.SOMMEl
Punda Capital Corp.
GraiNccLN'Y
JOHNCWESSm
Anthm CapiaL LP
Statement
of
William F. Dunbar
National Association
of
Small Business Investment Companies
before the
Committee on Small Business
United States Senate
July 13, 1995
34
Mr. Chairman and Members of the Committee:
I appreciate the opportunity to testify today. I am testifying in my capacity as chairman of
the National Association of Small Business Investment Companies, the professional trade
association representing the SBIC industry.
In my professional life, I am president of Allied Capital Corporation n and of Allied
Investment Corporation n, a wholly owned subsidiary which is an SBIC with $10 million
in funded capital. I also serve as executive vice president of all the other funds managed by
Allied Capital Advisers, which includes a second SBIC, the oldest SBIC in the country,
and an SSBIC.
I'd like to address several key issues regarding the SBIC program's historical success, its
impact on the capital formation efforts of small business, and what the industry believes is
a natural progression from 1992 landmark legislation to the privatization of the entire
program.
Historical Success
It is important to understand why Congress created our unique public/private partnership,
the Small Business Investment Company program.
The SBIC program found its beginning in a Federal Reserve study conducted in the mid-
1950's. "The study concluded that sources of long-term loans and equity financing for
small businesses were sorely inadequate. The Congress responded to the Federal Reserve
Board's observations by passing the Small Business Investment Act of 1958. Provisions
of this Act created the Small Business Investment Company program.
Over the 37-year history of the program, SBICs have invested close to $12 biUion in
100,000 small businesses around the country. Mr. Chairman, in 1994 alone, 2,348 small
businesses across the country received approximately $1 billion in SBIC financing. The
stories of SBIC participation in the start-up of Federal Express, Apple, and Intel are
famihar to many. The story of the hundreds of thousands of "Main Street, USA"
businesses financed by SBICs is not. And it is this story that truly illustrates the impact of
SBIC investments.
Many SBIC investments are in unglamorous retailers like the KC-K9 Bakery in Kansas
City, Missouri, or Table Toys Inc., in Houston, Texas. The market best served by SBICs
includes companies like WiUiam Brothers Lumber in Atlanta, Georgia, and Hanger
Orthopedic in New Canaan, Connecticut, whose presidents are here today to testify. All of
their stories are compelling. And all of their stories illustrate the significant role SBICs
play in fulfilling the needs of this underserved market within the small business
community.
It is companies like these that would never get the attention of the Wall Street investment
banking community because commissions for the firms would be far too smjdl.
Borrowings from local banks are either insufficient or impossible to find because small
companies often lack hard assets and because their capital needs are relatively small and
require a longer term. They need the investments that only an SBIC would be willing to
make.
Regional and Industry Diversity
Recent trends in the capital markets have actually decreased small business' ability to raise
long-term, patient capital. The funding gap for small growth companies remains acute —
35
particularly for businesses that are not high-technology-based or located in venture capital
strongholds such as New York, Massachusetts, and California. For thirty-seven years,
SBICs have worked to fill that gap. Close to 78% of small businesses funded by SBICs
are non-technology-based businesses and well over 50% of SBIC-backed companies were
located in areas other than Boston, New York, or the SiUcon Valley.
Job Creation
It is recognized that small growth firms are the primary generators of new jobs in America.
The job creation and economic development statistics of the SBIC program show this to be
among the most efficient programs supporting small business at an astonishing low cost to
the American taxpayer.
A study conducted by Deloitte, Haskins and Sells (now Deloine & Touche) in 1980
concluded that companies financed by SBICs have generated more than ten times the
employment growth of all other small businesses. The study found that SBIC-backed
companies are extremely efficient at generating substantial job growth. It was determined
that one permanent job was created with every $6,463 investment. If we adjust this
investment amount to current dollars based on prevailing inflation rates, one permanent job
is created for every 517,000 invested by an SBIC.
To add credence to these statistics, I'd like to share the job creation data from one of my
industry colleagues in Massachusetts. Pioneer Ventures L.P. invested 518 million in 27
small business concerns from 1984 through 1994. From the time of their original
investments to December 31, 1994, those 27 small firms created 6,700 new jobs with only
52,685 invested per job created. More impressively, these firms paid over 538 million in
federal, state and payroll taxes in 1994 alone. Mr. Chairman and Members of the
Committee, these are just 27 of the 100,000 small businesses across the country that have
received SBIC backing.
Cost to the Government
The cost of the SBIC program to the government, or perhaps more accurately the American
taxpayer, is more than reasonable over the program's history. Through September 30,
1994, 52.6 billion has been disbursed to regular SBICs by SB A. As of that date, SB A had
charged off only 5197 million. In addition, SBA projected that an additional 5170 million
would eventually be charged off against assets currently in the liquidation portfolio, and
557 million against assets currently in the active portfolio. The total cumulative cost at
fiscal year end 1994 on a "credit-loss" basis of the regular SBIC program would be 5424
million, or approximately 16% of total historical disbursements. This of course does not
take into account the operating expenses for the Investment Division of SBA, but neither
does it factor in tax revenues produced by the small business concerns, tax revenues
produced by the SBICs, or personal income taxes paid by the employees of the small
concerns.
The 1992 Investment Advisory Council report. Financing Entrepreneurial Business: An
Agenda for Action stated simply, "More than one-half billion dollars of direct taxes have
been paid by corporate-form SBICs to the federal government. Additionally, partnership
and corporate SBICs have paid in excess of 5800 miUion of dividends to their owners,
much of which is taxable income." The report concluded this discussion by observing,
"The Subcommittee could not estimate the level of taxes generated by small businesses
financed by SBICs, nor the personal income taxes of individuals whose jobs were created
by SBIC-financed companies. The statistics would be impressive. As an example, 5787.3
rniUion of taxes have been paid by Intel Corporation alone during its history." As I
mentioned earUer, the 27 companies that received backing from Pioneer Ventures paid over
538 miUion in federal, state and payroll taxes in 1994 alone. Mr. Chairman, we beheve
36
that the SBIC program is a unique public/private partnership that works. It works to create
jobs and it works to create wealth, prosperity, and opportunity for America's aspiring
entrepreneurs.
Legislative Overhaul
In 1989, the SBIC industry recognized the fact that in spite of the tremendous benefits the
program had already generated for the U.S. economy, there were shortcomings in the
operations of the program. Working closely with the leadership of both small business
committees in Congress, along with the U.S. Small Business Administration, and the
Investment Advisory Council, we helped overhaul the SBIC program.
The new, revamped SBIC program was signed into law in September of 1992 and the
regulations implementing the law became effective in April of 1994. The fundamental
problems of the program were addressed and corrected. Included in the overhaul were
many changes made to both the cost and the risk of the program to the federal government.
The changes in the SBIC program include corrections to major defects that will
considerably reduce program losses in the future. Some of the key revisions include:
1 . The creation of a new equity funding mechanism called the
Participating Security. The new participating security cures the mis-
match between the SBIC's sources and uses of funds.
2. New minimum capital requirements that will make SBICs
economically viable while their investments are growing.
3 . More frequent examinations of SBICs to protect both the
government's interests and the SBIC's.
4 . New management suitability criteria in an effort bring only
experienced venture professionals into the program.
5 . New valuation guidelines that will provide a consistent standard in
which to monitor an SBIC's portfolio company valuations.
6. New cost of money calculations that allow an SBIC to apply its own
average cost of coital calculations to set a base for their interest rate
ceiling. This feature allows an SBIC to structure its investments
based on its actual cost of funds.
7. Changing SB A's subordination position. SB A is no longer
subordinated to third party lenders.
8 . New credit- worthiness evaluations that are performed at the time of
licensing aid before each SBIC draws down leverage.
9. Preclusion of an SBIC's access to bankruptcy protection.
10. New criteria for ownership and management diversity.
Since the new program officially began in April 1994, 50 new SBICs have been licensed.
These 50 SBICs have raised $741 million in private capital, representing more private
capital entering the SBIC program in 14 months than in the last ten years combined. On
February 22, 1995, the first ftinding using the new Participating Securities allowed nine
37
SBICs to obtain $73 million from the coital markets for investment in small businesses.
This funding, coupled with private capital from the participating SBICs made available over
$100 million for investing into small businesses immediately.
A colleague of mine in a Kansas-based SBIC has already invested part of the proceeds
from this landmark funding in seven early-stage companies in the midwest. I stress early-
stage because it is the Participating Security that permits him to provide the long-term
patient capital those seven companies will need to grow strong, create jobs, create wealth
within their communities, and generate tax revenues.
The Participating Security enables SBICs to invest in riskier, smaller businesses by
deferring a portion of the interest which SBICs pay to the federal government in the earlier
years of the SBICs life. In exchange for the deferral, the government receives a
participation in the profits of the SBIC, thus creating the strong possibility that the SBIC
program may cost much less in the near future and may actually generate a profit for the
government.
Importance of the Debenture Program
It is important to clarify that the "new" SBIC program does not apply only to SBICs using
the new Participating Security. The "new" SBIC program includes SBICs using the
Debenture instrument as well. The industry views the "new" SBIC program as the new
environment in which aU SBICs operate since the 1992 legislation and 1994 regulatory
implementation of the legislation.
As outlined in the ten key revisions earlier, the regulatory changes mutually improve the
operating environment for both SBICs and the federal government. While the new
Participating Security clearly addresses one of the basic flaws of the program, the
Debenture instrument remains a vital part of the SBIC program. For SBICs that make
loans, the Debenture is still an ideal form of leverage. SBICs continue to use the debenture
form of financing to make loans to healthy businesses that don't have the same "home run"
return potential that is characteristic of companies receiving equity investments. These
lender SBICs also fill a niche in the small business community that is desperately under-
served, providing long-term capital to entrepreneurs who prefer to maintain 100%
ownership in their companies.
As of July 7th, 17 SBICs using the Debenture instrument have been licensed within the
"new" program. These 17 new SBICs alone brought $188 million in private capital into
the program. Combining this fresh capital with the nearly $2 billion in private capital raised
by Debenture-using SBICs hcensed prior to the new regulations and the $564 million in
leverage already drawn down, the small business community has access to a considerable
pool of long-term, patient capital.
The Future of the SBIC Program
Mr. Chairman, our industry recognizes and appreciates the environment in which you and
your colleagues in the Congress are working. The calls to reduce the deficit, decrease die
size of government, and balance the budget are loud.
In this environment of fiscal restraint, we beheve it is critical that we continue to explore all
possible means of reducing the role of the federal government and the budgetary cost to the
federal government of the SBIC program — without undermining the tremendous
contribution the program makes to the U.S. economy. Our industry is committed to
studying every possible means of reducing the cost of die SBIC program to the American
taxpayer.
38
The Privatization Continuum
Prior to 1972, the SBIC program was entirely underwritten by the SB A directly purchasing
SBIC debentures. This system of funding was dollar-for-dollar and reflected the full cost
of the program on the budget. From 1972 through 1986, funding for the program came
from the Department of the Treasury Federal Financing Bank (FFB). This funding
mechanism dso produced dollar-for-dollar budgeting. Since 1986, funding for the
program has been provided by the public capital markets, primarily institutional investors.
The SB A guarantees payments of principal and interest to the investors. Under this method
of funding, the government scores on the budget each year the present value of the
expected losses over the hfe of the debentures, which is called the subsidy rate. The
budget impact under this funding system is only a percentage of the total leverage
guaranteed.
We believe formation of a government-sponsored enterprise (GSE) to fund and manage the
program is the logical next step along the privatization continuum. Ultimately, the SBIC
program would be entirely privatized when the GSE drops its access to the Treasury
backstop and becomes completely private just as Sallie Mae is seeking to do now.
The Venture Capital Marketing Association
NASBIC's proposal to privatize the SBIC program provides a means to address the critical
public purpose for which the program was designed — to provide for the "growth,
modernization and expansion of small business." Our proposal presents the framework of
creating a private financing stracture with continuous oversight by the government and
built-in protections to ensure safety and soundness. (A copy of NASBIC's proposal,
including financial models, is attached to this testimony for your review.) Under the
privatization proposal, the SBIC program will be lifted out of the SBA and moved into a
new private corporation created by an Act of Congress. This new corporation will be a
government-sponsored enterprise (similar to Fannie Mae) which will no longer need
Congressional budget authority or appropriations. The new entity will have a set of
characteristics giving the corporation status similar to those provided to Fannie Mae and
Sallie Mae which include a charter set forth by an Act of Congress, private ownership with
SBICs owning the voting common stock, control by a Board of Directors, Congressional
oversight of the corporation's activities, and the authorization to make loans and
investments. We propose that the new corporation be named the Venture Capital Marketing
Association, or Vickie Mae.
The new corporation will be a privately owned and privately managed for-profit
corporation. Existing and newly formed SBICs will be stakeholders in the corporation
through the purchase of voting common stock. Policy direction for the corporation, within
specific statutory parameters set by Congress, will be provided by a Board of Directors.
Tlie majority of the Board will be elected by the voting common stockholders, with the
balance appointed by the President. The day-to-day operations will be carried out by a
highly qualified professional management team.
Existing SBICs will provide Vickie Mae's initial capitalization through the purchase of
common stock. On a continuing basis, the corporation will build its capital base through
capital contributions from newly formed SBICs, charges to SBICs for funds they raise
through the corporation, capital contributions for increases in the capital of operating
SBICs, and internally generated retained earnings. The corporation will also eam its capital
base by profitable operations from the spread on funds in managing the current portfolio at
SBA and from fees charged to SBICs. Once the corporation has shown positive
performance for several years it may raise additional capital through the sale of stock tp
private investors, such as pension funds, banks or other institutional investors. Under
39
privatization, the guarantee is implicit. The market will determine the price of Vickie Mae
securities at a small spread to Treasury bonds and based on the characteristics of the
government sponsored enterprise.
The enclosed NASBIC proposal provides detailed information on exactly how the new
government-sponsored enterprise (GSE), or "Vickie Mae" would work. The proposal also
explains how Vickie Mae would regulate SBIC business practices, how the government
would oversee the operations of the corporation, and the acmal budget treatment of this
potential GSE. We have brought together industry professionals, investment bankers,
legal counsel, consultants and accountants to develop the financial models for Vickie Mae.
Those models are also included for your review.
We are confident that the benefits of privatizing the SBIC program will be substantial.
Here's why.
The public policy goals will continue to be met.
• Over the next five years, the small growth companies in which SBICs
invest will create over 300,000 permanent new jobs.
• New tax revenues will be produced from taxes paid by the expanded
SBIC industry. On a combined basis with taxes from the companies in
which SBICs invest, new tax revenues should exceed $100 million per
year, further supporting the deficit reduction goals of Congress.
• SBA's regulatory and support offices for the SBIC program will not be
needed — creating additional savings realized from reductions in staff and
related overhead expenses.
• The budget savings from the new system will be more than $300 million
over the next five years.
Small business will beneflt.
• The new system will produce a material increase in the flow of
investments into small growth firms. We estimate that $5 billion over the
next five years will be invested in American small growth firms.
• There will be an expanded and stable source of early-stage venture
financing for new entrepreneurial start-up companies.
• The new system will provide significant amounts of expansion capital
for small firms that have been shut out of the market for commercial bank
financing.
This privatization initiative serves as the stepping stone to full privatization. SBIC industry
professionals, myself included, foresee this government sponsored enterprise as a vehicle
to full privatization where all ties, both budget and oversight responsibilities, are severed.
Vickie Mae, given the opportunity, would become a stand-alone, for-profit corporation
serving the financing needs of small growth companies in America.
The overwhelming expansion of the SBIC program and of the demand for leverage by
SBICs from the federal government has placed enormous pressure on current appropriation
levels. The funding levels required to meet the demand by licensees, and the needs of
40
small businesses themselves, dramatically exceeds the current appropriations. There is a
tremendous sense of urgency to begin working towards full privatization. We believe that
it is truly possible to design a program that would reduce or eliminate the need for direct,
annual appropriations while providing a consistent source of funding from the capital
markets to enable SBICs to continue providing long-term patient capital to small growth
companies.
We understand that a full shift to privatizing the SBIC program could be a lengthy and
arduous one, but we are willing to work with the Congress. In the meantime, we urge
your support of current and future funding levels for the SBIC program.
Today's SBIC; New Design. Renewed Commitment
In a study conducted by Arthur Andersen's Enterprise Group and National Small Business
United in 1993, thirty percent of the survey's respondents claimed that access to capital is a
significant challenge to the growth and survival of their small and mid-sized companies. In
preparation for the White House Conference on Small Business, SBA's Office of
Advocacy conducted a smdy called, "Small Business and Entrepreneurship in the Twenty-
First Century." Various focus groups were called together to discuss the obstacles and
opportunities that small businesses will face in the year 2005. The discussions were
provocative. Repeatedly, the focus groups determined that gaining access to capital will be
a linchpin to small business and entrepreneurial growth.
The SBIC program has served the small business community well over its 37-year history.
We ask that you Mr. Chairman and Members of the Committee consider all possible
alternatives to keep the funding sources for SBICs stable, either by maintaining
appropriations levels at or above the President's budget, or a by privatization initiative.
Today's SBICs are better managed and better capitalized. They operate in a more
reasonable regulatory environment and are successfully filling the capital needs of sniall
business. Most importantly, today's SBICs are committed to invest in and work with
America's small growth companies to help them now and well into the future.
Again, thank you for this opportunity to share our perspective of the SBIC program. We
have appreciated your leadership as Chairman of the Senate Committee on Small Business
and look forward to working more closely with you and Members of the Committee to
make the new SBIC program better and American small businesses stronger. Thank you
and I submit this testimony for the official record of the committee.
41
A PROPOSAL
TO
PRIVATIZE THE SBIC PROGRAM
THE NATIONAL ASSOCIATION
of
SMALL BUSINESS INVESTMENT COMPANIES
(NASBIC)
June, 1995
42
PRIVATIZING THE SBIC PROGRAM
Contents
Item Page
Introduction 1
Why It Makes Sense to Privatize the SBIC Program 2
What Is Vickie Mae 3
How Vickie Mae Will Work 4
Vickie Mae Regulation of SBIC Business Practices 5
Government Oversight of Vickie Mae 6
Factors Which Mitigate the Government's Risk 7
Budget Treatment of Government-Sponsored Enterprises ("GSEs") .... 8
Highlights of SBIC Operational Data 10
Highlights of the Vickie Mae Financial Projections 11
The Model
Persons Who Developed the Model 13
Variables in Building the Model 14
Probability of Various Outcomes 15
CPA's Compilation Report (attachment)
Financial Projections (attachment)
Assumptions and Accounting Policies (attachment)
43
INTRODUCTION
This proposal sets forth a viable plan to 'privatize* the Small Business Investment Company
(SBIC) program - a program that is now managed by the Small Business Administration (SBA).
Small business concerns are continually faced with serious difficulty in obtaining long-term
patient capital required for growth and development. Commercial banks do not furnish such
financing. Private venture capital funds selectively invest large amounts in a narrow range of
companies with exceptional prospects for growth. As a result, there is a huge gap between the
small business sector's critical need for long-term growth capital and the availability of this
type of financing. The SBIC industry was designed to fill this gap and provide capital to this
most important segment of the U.S. economy. This proposal provides a means to address this
critical public purpose through a private financing structure, with continuous oversight by the
government and built-in protections to assure safety and soundness.
The current SBIC program operates as a partnership between the private sector and the Federal
government. SBICs are private investment companies that provide long-term patient capital to
small businesses. SBICs are capitalized with private funds and managed by skilled venture
professionals who make their investment decisions without interference from the government.
SBICs have invested in excess of $11 billion in more than 100,000 small growth companies in
the past 35 years, and have produced a net positive return to the government.
The program is currently housed in the Small Business Administration (SBA), and SBICs are
subject to licensing and regulation by the SBA. As licensed and regulated companies, SBICs can
raise additional capital by selling SBA-guaranteed securities in the capital markets. While this
system provides an increased pool of funds for SBIC investments in small business, it also
requires budget authorization and annual appropriations by Congress.
Under the privatization proposal the SBIC program will be lifted out of the SBA and moved into a
new private corporation created by an Act of Congress. This new corporation will be a
"government-sponsored enterprise" (similar to Fannie Mae) which will no longer need
Congressional budget authority or appropriations. It would be named the Venture Capital
Marketing Association, or Vickie Mae.
The benefits of privatizing the SBIC program will be substantial. The Federal government will
realize significant budget savings while reducing the size of a government agency - SBA. The
small growth firms in which SBICs invest will create new permanent jobs and generate new tax
revenues. Small businesses will gain access to capital markets now closed to them, and there
will be expanded opportunities for new start-up companies. Finally, the system of financing
small business will be materially improved by providing SBICs a dependable flow of funds for
investment.
44
WHY IT MAKES SENSE TO PRIVATIZE THE SBIC PROGRAM
Public Policy Benefits
• Budget Savings - The new system will reduce budget outlays by approximately $250
million over the next five years.
• Downsizing SBA - SBA's complex regulatory and support apparatus for the SBIC
program will not be needed. A full SBA division of over 90 staff positions can be cut,
and additional savings realized from reductions in support personnel and related
overhead costs.
• Increased Tax Revenues - New tax revenues will be realized from corporate taxes of the
growth companies in which SBICs invest and income taxes of their employees. New tax
revenues also will be produced from taxes paid by the expanded SBIC industry. On a
combined basis, new tax revenues from these sources should exceed $100 million per
year, further supporting the deficit reduction goals of Congress.
• Job Creation - Over the next five years, the small growth companies in which SBICs
invest will create over 300,000 permanent new jobs.
• New Technologies - The increased number of SBICs investing in new and expanding
high-tech companies will bolster the development of new technologies.
• Reduced Regulations - A large block of highly complex SBA regulations, which federal
regulators now use to micro-manage the SBIC program, will be wiped off the books.
Snfiall Business Benefits
• Increased Access to Growth Capital - The new system will produce a material increase
in the flow of investments into small growth firms, estimated in the range of $5.0
billion over the next five years.
• New Opportunities for Start-Ups - New entrepreneurial start-up companies, which
have very limited access to capital, will have an expanded and stable source of early-
stage venture financing.
• Enhanced Capacity for Expansion - The new system will provide significant amounts of
expansion capital for small firms that have been shut out of the market for commercial
bank financing.
45
WHAT IS VICKIE MAE
A new off-budget, government-sponsored enterprise (GSE), named the Venture Capital
Marketing Association, or "Vickie Mae' would be chartered by Congress to act as a capital
bank for the SBIC industry. This new corporation will be similar to the Federal National
Mortgage Association (Fannie Mae) and the Student Loan Marketing Association (Sallie Mae).
It will replace all of the SBIC program functions now performed by SEA.
Ownership - The new corporation will be a privately owned and privately managed,
for-profit corporation. Existing and newly formed SBICs will be stakeholders in the
corporation through the purchase of voting common stock.
Management - Policy direction for the corporation, within specific statutory
parameters set by Congress, will be provided by a Board of Directors. The majority of
the Board will be elected by the voting common stockholders, with the balance appointed
by the President. Day-to-day operations will be carried out by a highly-qualified
professional management team.
Status as a "Government-Sponsored Enterprise" fGSE^
The new entity will have a set of characteristics giving the corporation status as a
'government-sponsored enterprise.' These features, which are the same as those
provided to Fannie Mae and Sallie Mae, include:
• Chartered by an Act of Congress.
• Private ownership with SBICs owning the voting common stock.
• Control by a board of directors, the majority of whom (10) are elected by the
stockholders (the SBICs). Five public directors are appointed by the President.
• Congressional oversight of the corporation's activities.
• The corporation is a financial institution authorized to make loans and
investments, and its securities are legal investments for federally-supervised
financial institutions.
Capitalization - Existing SBICs will provide the corporation's initial capitalization
through the purchase of common stock. On a continuing basis, the corporation will build
its capital base through:
• Capital contributions from newly-formed SBICs,
• Charges to SBICs for funds they raise through the corporation,
• Capital contributions for increases in the capital of operating SBICs.
• Internally generated retained earnings.
In addition, after the Corporation has shown positive performance for several years it
may be able to raise additional capital through the sale of stock to private investors, such
as pension funds, banks or other institutional investors.
46
HOW VICKIE MAE WILL WORK
Fundinp Mechanism
Funds From the Capital Market - The corporation will serve as capital bank for SBiCs.
It will raise tunds by selling its own securities in the capital markets securitized by
packages of SBIC securities. The corporation's "government-sponsored enterprise"
status will enable it to raise funds at a rate spread slightly above comparable U.S.
Treasury securities, making the effective cost of funds to SBICs reasonable.
Funding for SBICs - The corporation's principal activity will be to provide funding for
SBICs through the purchase of their securities. The Board will establish eligibility
standards for SBIC funding. The corporation will be authorized to provide financing
through a variety of debt and equity securities which match the capital needs of SBICs.
Management of the Outstanding SBIC Portfolio
Debentures of Operating SBICs - All currently outstanding SBIC Debentures and Preferred
Stock in SBA's portfolio would be transferred to the corporation under a service contract.
The corporation would manage and sen/ice those securities for the government for a fee.
Participating Securities of Operating SBICs - All Participating Securities in SBA's
portfolio would be acquired by the corporation and managed by the Corporation for its own
account.
The SBIC LiQuidation Portfolio at SBA
All SBIC securities and assets in liquidation status at SBA would also be transferred to the
corporation under a service contract. The corporation would manage and service the
liquidation of those assets for a fixed fee, plus an incentive fee for achieving outstanding
recoveries.
47
VICKIE MAE REGULATION OF SBIC BUSINESS PRACTICES
Entry Into The Program and Qualifications To Do Business - Existing SBICs in
good standing will automatically qualify to do business with the corporation. The Board will
establish standards of entry for new SBICs, including standards for minimum capitalization,
quality and experience of management, probability of adequate profitability and financial
soundness.
Regulation of SBICs - SBICs will enter into a contract with the corporation, under which
they will be contractually bound to abide by the corporation's operating rules and standards.
Within guidelines spelled out by Congress in the enabling legislation, the Board will
establish rules governing all appropriate aspects of an SBICs business operations. These
will include definitive rules in the major regulatory areas covered by the current program,
which are:
Conflict of interest transactions are prohibited.
Investments can only be made in the qualified small businesses.
Control of small firms is restricted.
Diversification of investment risl< is required.
Investments in certain highly speculative or unlawful activities are prohibited.
Each SBIC will be subject to examination by the corporation to assure the SBIC Is in
compliance with the corporation's rules.
Enforcement of the Rules - The enabling legislation will require the corporation to
adopt measures to assure compliance with its rules, and will give the corporation several
specific enforcement powers, including:
• Termination or suspension of agreements between the corporation and an SBIC,
• Termination of an SBICs qualification to do business with the corporation,
• Assessment of penalties against an SBIC or its officers, directors or general partners,
• In appropriate cases, the authority to remove officers, or directors or general
partners of the SBIC,
In appropriate cases, the authority to tat^e over control and operation of the SBIC, and
• In cases involving potential criminal activity, referral of violations to the U. S.
Attorney.
The corporation will also have access to all appropriate civil remedies where an SBIC has
breached its contractual agreement, including, acceleration of debt in cases of default,
actions to enforce contractual covenants, and initiation of litigation against the SBIC.
48
GOVERNMENT OVERSIGHT OF VICKIE MAE
Oversight of the Corporation's Financial Performance
Standards For Financial Safety and Soundness - The enabling legislation will establish
standards and tests of financial safety and soundness for the corporation. These standards
will be similar to those required for other government-sponsored enterprises.
Compliance with these standards will be monitored by a designated government official.
Independent Audits - The corporation will be audited annually by an independent CPA.
Government Oversight - The corporation will make an annual report to Congress and the
President on the corporation's operations, including an assessment of the corporation's
financial safety and soundness.
The Small Business Committees of Congress and SBA will have authority to review the
corporation's compliance with the Congressionally established financial standards. The
corporation will be subject to a financial audit at any time by SBA, or by GAO at the
request of either Small Business Committee of Congress.
The Small Business Committees of Congress. GAO and SBA will have access to the
corporation's financial books and records at any time.
Treasury Approval of Securities Issued bv the Corporation - All obligations Issued by
the corporation will require approval by the Treasury Department. Similar Treasury
approval is required for securities issued by all other government-sponsored
enterprises, such as Fannie Mae and Sallie Mae.
Oversight of the Corporation's Regulatory Performance
Regulatory Standards - The enabling legislation will establish basic standards for the
corporation's regulatory activities.
Government Oversight - The corporation will make an annual report to Congress and the
President on the corporation's operations, including an assessment of the corporation's
regulatory activities.
The Small Business Committees of Congress and SBA will have full authority to review the
rules established by the corporation for SBIC business practices, and the corporation's
regulatory operations, at any time.
The Small Business Committees of Congress, GAO and SBA will have access to the
corporation's regulatory books and records at any time.
49
FACTORS WHICH MITIGATE THE GOVERNMENT'S RISK
A series of factors inherent in the Vickie Mae proposal strongly mitigate the government's risk
of loss or the Treasury backstop authority ever being used These include:
Motivation to Make Vickie Mae work - The success of Vickie Mae is quite important to
every SBIC because they are investors in the corporation. But, of far greater importance is the
SBIC industry's motivation to assure that Vickie Mae succeeds because of the consequences of
failure. The SBICs clearly realize that if the Congress and the Treasury are ever required to
"bail out' the enterprise, it would literally mean the end of the industry.
Fundamental Risk Reduction Changes in the Program - The reform legislation of
1992, and the new regulations adopted to implement that law, eliminated prior practices which
had led to losses in the SBIC debenture program. These changes include new requirements for:
substantially increased private capital for each SBIC; correction of the high-risk mismatch
between an SBICs borrowing and its investments: lower leverage ratios; consistent valuation
standards where none existed before; diversity between management and ownership, the lack of
which was previously abused; elimination of high-risk real estate plays; limitations on SBA's
subordination as a creditor; and a series of regulatory changes that now give SBICs the means to
generate additional income. While difficult to quantify, it is reasonable to posit that
administration of the program under these new regulations will materially reduce the rate of
loss which has been associated with the conduct of the program over the past thirty-five years.
Financial Performance Standards -The enabling legislation sets forth a series of
financial standards which must t>e continually met by Vickie Mae. They involve such matters as
requirements for minimum capital, tests of credit risk and interest rate risk, valuation of
linked portfolio assets, and standards for dividend distributions. These provisions will help to
assure the financial safety and soundness of the corporation's operations.
Improved Quality and Experience of SBIC Managers - Qualification requirements for
SBIC managers were substantially increased when the program was revised in 1992.
Applicants for an SBIC license must now have extensive experience in venture investments and
a proven, successful track record. This requirement for management to have a high level of
proven ability and experience will be continued under Vickie Mae, giving greater assurance
that SBIC portfolio investments will be of the best quality.
Industry's Private Capital at Risk Before the Government - As the projections
indicate, once the corporation goes through an initial growth period, its retained earnings
increase dramatically (to approximately $500 million) and capital contributed by the SBICs
continues to grow. This equity base provides a substantial cushion to shield the government's
exposure to risk. In addition, the aggregate capital of the industry grows rapidly to $3.0
billion, further insulating the government from loss.
Corporate Leadership From Industry Professionals - The majority of Vickie Mae's
Board of Directors will be drawn for the leadership of the SBIC industry. Their direction will
insure that policies of the corporation are guided by a group of professionals who understand
the venture business in detail and have a vested interest in the corporation's success.
Professional Management of the Corporation - The company's day-lo-day operations
will be managed by a highly-qualified team of private-sector professionals. Vickie Mae will be
able to attract a caliber of staff similar to Fannie Mae and Sallie Mae. With all due respect,
this will be a marked improvement over the management of the program by the government
employees in SBA's Investment Division.
50
BUDGET TREATMENT OF GOVERNMENT-SPONSORED ENTERPRISES
The History of GSEs
Since the 1930s, Congress has created a number of government-sponsored enterprises
('GSEs') to provide capital to various sectors of the economy, including homeowners,
farmers, colleges and students. While the GSEs received Federal charters provided in
Federal statutes, GSEs are privately owned and operated. They are limited in their activities
to specific economic sectors and given certain benefits that help them accomplish their
goals.
GSEs include the following entities: the Federal Home Loan Mortgage Corporation ('Freddie
Mac"), the Federal National Mortgage Association ('Fannie Mae"), and the Student Loan
Marketing Association ("Sallie Mae").
None of the GSEs are subject to the Congressional budgetary process because the GSEs are not
under the control of the U. S. Government. In light of the public purposes described in the
charters of these entities, the Government has an interest in the activities of the GSEs. The
President of the United States appoints one-third of the directors of Fannie Mae and Sallie
Mae. And, there is explicit regulation of the safety and soundness of each GSE by a Federal
regulator.
Because of the Federal charter, the public purposes and the Federal regulation of GSEs, the
capital markets view the GSEs as excellent credit risks. Accordingly, debt obligations of the
GSEs are issued at yields with relatively narrow spreads over comparable maturities of debt
obligations of the U. S. Treasury.
The Omnibus Budget Reconciliation Act of 1990 fthe "Acn
In 1990, a number of proposals were made to the Congress to significantly alter the
exclusion of GSEs from the budgetary process. The so-called summit agreement on the
budget, reached by the Administration and the 101st Congress and memorialized in the
Omnibus Budget Reconciliation Act of 1990 (the 'Act") rejected these proposals. In lieu
thereof, a study was mandated from the Treasury Department on the financial safety and
soundness of the GSEs, the adequacy of the existing regulatory structure for GSEs and the
financial exposure of the Federal Government posed by GSEs.
The Act did contain the Credit Reform Act of 1990 as one of its titles (the 'Credit Acr),
which dealt principally with the budgetary treatment of direct loans and loan guarantee
programs. The Congress concluded that the cash accounting basis of the Federal budget
overstated the real economic costs of direct loan programs and understated the real economic
costs of loan guarantee programs in the year the loans were made. The Act provided for a
revised system of accounting for Federal credit programs that required the appropriation of
budget authority equal to the estimated net present value of the cash flows associated with
Federal direct loan and loan guarantee programs.
But, the Conference Report on the Act made a clear distinction between the budgetary
treatment of GSEs and direct or guaranteed loans. It stated:
'The Senate amendment defines a Government-sponsored enterprise (GSE) to
emphasize that to qualify as a GSE and thereby escape Budget Act treatment, a GSE
51
must: have a Federal charter; be privately owned; be controlled by a board of
directors elected by the owners; and be a financial institution with powers to
make loans, guarantee loans, issue debt or guarantee the debt of others. Further,
a GSE could not exercise powers that are reserved to the Government (e.g. taxing
powers or regulating interstate commerce), commit the Government financially,
or employ Federal civil servants." (Omnibus Budget Reconciliation Act of 1990,
Conference Report, p. 1164)
Vickie Mae Qualifies as a GSE
The legislation proposing the creation of Vickie Mae contains all of the provisions cited in
the conference report. Vickie Mae would have the following characteristics to qualify It as a
GSE
• A Federal charter - it is chartered by an Act of Congress;
• Private ownership - ownership by SBICs who are the stockholders;
• Controlled by a board of directors elected by the owners - the owners elect ten of the
fifteen members of the board of directors;
• A financial institution with powers to make loans, guarantee loans, issue debt or
guarantee the debt of others - Vickie Mae is empowered to carry out these functions.
Vickie Mae would not exercise powers reserved to the Government.
Vickie Mae would not commit the Government financially (the Treasury backstop is
contingent. It requires an appropriation of funds by Congress, and the Treasury's
determination to use those funds is discretionary).
Vickie Mae would not employ Federal civil servants.
If Congress were to enact the Vickie Mae legislation in its proposed form, there is no doubt
that Vickie Mae will qualify as a GSE and the activities and operations of Vickie Mae will not
be subject to the limitations and restrictions of the Federal budgetary process.
The Potential Success of Vickie Mae Compared to Other GSEs
Vickie Mae has the potential to be as successful as such other GSEs as Fannie Mae, Freddie
Mac and Sallie Mae. Those GSEs have had remarkable success because they have been able to
achieve high profit levels by maximizing their GSE benefits and minimizing interest rate
(borrowing) and credit risks.
Vickie Mae will be investing in venture capital enterprises which will have greater
potential for profit than investments by the other GSEs. but also greater investment risks.
However, SBICs have proven that the venture capital industry can be profitable while
producing enormous benefits for the American economy. Additionally, the recent legislation
and regulatory changes to the SBIC program have materially reduced the risks historically
associated with this investment program. Creating Vickie Mae will move the program from
cdntrol of the SBA into the private sector, providing Vickie Mae the opportunity to devote
skilled professionals to the direction and management of the corporation's affairs.
Continued access to a flow of capital provides the motivation to make Vickie Mae a successful
operation. Vickie Mae will give the SBIC industry an opportunity to grow and prosper, and
the chance to attract an amount of private capital which will further enhance Vickie Mae's
ability to achieve success.
52
Highlights of SBIC Operational Data
1998 2001
Number and Composition
of New SBICs
Participating Securities SBICs
76
110
Debenture SBICs
52
21
Total
133
201
Private Capita! of New SBICs
($ in millions)
Participating Securities SBICs
$1,520
$2,200
Debenture SBICs
570
910
Total
$2,090
$3,110
2004
140
121
261
2007
161
149
310
2010
176
US.
354
$2,800 $3,220 $3,520
1.210 1 490 1 780
$4,010 $4,710 $5,300
Leverage Taken Down
($ in millions)
Participating Securities SBICs
$490
$445
$371
$385
$595
Debenture SBICs
$261
$294
$283
$362
$473
Investment Dollars Disbursed
($ in millions)
Participating Securities SBICs
$694
$627
$523
$538
$840
Debenture SBICs
$352
$397
$382
$489
$630
Number of Investments
All SBICs
1,897
1,605
1,225
1,201
1,485
10
53
Highlights of the Vickie Mae Financial Projections
Income Information
Net Investment Income
Other Income
Income before taxes
Income taxes
Net Income
1998
2001
2004
2007
2010
($ in millions)
($74.1)
$ 7.1
$126.2
$161.1
$114.7
1S.0
U.
(4.71
(9.91
(11.51
(56.1)
8.2
121.5
151.2
103.2
Q.
Q.
L^2^)
(52.91
(36.1)
($56.1)
$8.2
$79.0
$98.3
$67.1
Balance Sheet
Information
Assets
$2,126
$3,760
$4,238
$4,363
$5,176
Liabilities
2.156
3,787
4,054
3,916
4,494
Equity
Invested Capital
45.1
80.2
108.5
135.3
172.2
Retained Earn
ings
(75.1)
(107.6)
75.9
312.0
510.3
11
54
THE MODEL
55
Persons Who Developed the Model
SBIC industry:
William F. Dunbar
Edward C. Brown
Walter Cunningham
Christopher W. Dick
Michael F. Elliot
Keith R. Fox
David McL Hillman
Suzanne Kriscunas
Warren L Miller
James F. O'Donnell
James A. Parsons
Raymond R. Rafferly, Jr.
William Reisler
Peter F. McNeish
James M. Trainor
Executive Vice President, Allied Capital Advisers, Inc.
Managing Partner, Hanifen Imhoff Capital Partners
General Partner, Unco Ventures, Ltd.
Partner, Pioneer Ventures, LP.
Director, NationsBank Leveraged Capital Group
President, Exeter Venture Lenders, L.P.
Executive Vice President, PNC Equity Management Corp.
Director, Banc One Capital Partners Corp.
President, Florida Capital Ventures, Ltd.
Chairman, Capital for Business, Inc.
General Partner, RFE Investment Partners
General Partner, Meridian Venture Partners
Vice President, Kansas Equity Partners
President, NASBIC
Vice President, NASBIC
Certified Public Accountants:
F.H. Heerde, Partner Partner, Financial Advisory Services, Coopers & Lybrand
Michael E. Imber Coopers & Lybrand
Investment Bankers:
Michael K. Clare
Frederick O. Terrell
Vice President, Chemical Securities, Inc.
Managing Director, CS First Boston
Legal Counsel:
James E. Murray
Michael B. Staebler
Partner, Brown & Wood
Partner, Pepper. Hamilton & Sheetz
Cpnsullanls:
Robert J. Dotchin
Frank H. Hill
Kenneth S. Levine
Partner. The Advocacy Group
Partner, The McMillan Group
Partner. Wunder, Diefenderfer, Cannon & Thelen
13
56
Variables In Building the Vickie Mae Model
Number of New SBICs Licensed - While we have attempted to show a pattern of new licensees
that is consistent with current interest in the program, it is inherently difficult to predict
what will happen when the program is privatized. Based on the number of new SBICs
licensed in fiscal year 1994 (35) and the number of pending licenses (60), we determined
that the projected schedule of new licenses (for both participating securities and
debentures, net of withdrawals or liquidations) was conservative and reasonable.
Default Rate of SBICs Using Debenture Leverage - While the debenture form of leverage is
not a new program, there are many things about the program today and in the future that are
different from the history of the past 35 years. First, most of the capital in the program
during the period covered by the model will be coming from new SBICs with new managers.
Second, these new SBICs will be far better capitalized than in the past ($10 million average
private capital versus $3 million in the past). Third, the new regulations adopted pursuant
to the 1992 reform legislation will curtail many of the practices that led to the high default
rales of the past. Nonetheless, despite the fact that the model is very conservative in using a
default rate as high as the historical average, projecting performance of a new crop of SBICs
is inherently risky and has a significant impact on the results of Vickie Mae.
Investment Performance of SBICs using Participating Securities - Since the Participating
Securities form of leverage Is a new program, we have no historical information to use in
the Vickie Mae model. We have used the best industry information available in constructing
the model for these new SBICs. Venture Economics, publisher of the Venture Capital
Journal, has done comprehensive studies of investment performance by non-SBIC venture
funds over the past 20 years. The Vickie Mae model has used a more conservative version of
the venture industry averages. Even though we have assumed investment returns that are
well below the industry averages over a long period of time, it is inherently difficult to
project performance of new venture capital funds.
Timing of Returns From Participating Securities - An issue closely related to investment
performance is the timing of the cash received from the SBICs using Participating
Securities. Since payments are not made according to a fixed schedule, it is more difficult to
project exactly when an SBIC will distribute cash to Vickie Mae. We again have used data
from the Venture Economics performance surveys as the basis for the timing of returns, and
again we have used assumptions that are more conservative than the industry data. This set
of assumptions has the greatest impact on Vicki Mae's cash balance in the early years of the
model, and the actual results could vary widely from the projection.
Vickie Mae Overhead and Staff Expenses - The Vickie Mae model assumes an initial level of
General and Administrative expenses of $5.75 million, increasing by 5% each year
thereafter. This assumption is consistent with $6.0 million for administrative expenses
which SBA has used in its modeling.
14
57
Probability of Various Outcomes
NASBIC is In the process of developing different scenarios, which Coopers & Lybrand will
compile, that would show the financial impact of outcomes that are less optimistic than our
"base case" set forth in the model, and also outcomes that are more optimistic. The base case
represents the industry's best estimate of expected results while using very conservative
assumptions. For example, the investment returns and default rates are worse in the base case
than what the industry has experienced over time. While it is difficult to assign probabilities to
these various outcomes, we believe that the likelihood of the actual results being worse than the
base case is less than 20%, while the probability of the actual outcome being better than or
equal to the base case is 80%.
15
58
VENTURE CAPITAL MARKETING ASSOCIATION
(A Proposed Government Sponsored Enterprise)
PROJECTED FINANCIAL STATEMENTS
as of January 1, 1996 (assumed date of Inception)
and for the fifteen years ending December 31, 2010
59
VEh4TURE CAPITAL IWIARKETING ASSOCIATION
(A Proposed Government Sponsored Enterprise)
PROJECTED RNANCIAL STATEMENTS
88 of January 1, 1996 (assumed date of Inception)
and for the fifteen years ending December 31, 2010
TABLE OF COfOTENTS
Projected Financial Statements
Accountants' Compilation Report 1
Projected Balance Sheets 2
Projected Statements of Income and Retained Earnings 4
Projected Statements of Cash Flow 6
Summary of Significant Projection Assumptions
and Accounting Policies 8
Supplemental Information
Schedule I • Participating Security SBICs Licensed as of
Decemt}er 31 , 1994: Internal Rate of Return (IRR)
and Cash Distribution Assumptions
Schedule II - Participating Security SBICs Licensed after
December 31 , 1994: Internal Rate of Return (IRR)
and Cash Distribution Assumptions
Schedule III - Participating Security SBICs Licensed after
December 31 , 1 994: Ratios of Cumulative Cash Distributions
to Cash Investments
Schedule IV - Participating Security Segment: Summarized
Projected Income and Cash Flow Statements
Schedule V - Debenture Segment: Summarized Projected
Income and Cash Flow Statements
60
/^ ^ ^^ _ „_ Coopers & Lybrand L.L.P.
Coopers
&Lybrand
a protessionai services lir
ACCOUNTANTS' COMPILATION REPORT
The Board of Governors
National Association of Small Business Investment Companies
We have compiled the accompanying projected balance sheets and the related projected
statements of income and retained earnings and cash flow of the Venture Capital Marketing
Association (Vickie Mae), a Govennment Sponsored Enterprise (GSE) proposed by the
National Association of Small Business Investinent Companies (NASBIC), as of January 1,
1996 (assumed date of inception), and fortiie fifteen years in tiie period ending December 31,
2010. The projections have been compiled in accordance with standards established by the
American Institute of Certified Public Accountants (AICPA), except that the management of
NASBIC has elected to present a projection period of fifteen years, which exceeds the
projection period of three to five years specified by AICPA standards.
The accompanying projections and this report were prepared for the purpose of assisting
Members of Congress, their staff and other United States Government officials in evaluating
tine proposal by NASBIC to establish a GSE to provide financing to small business investment
companies and should not be used for any other purpose. Accordingly, the accompanying
projections and this report should not be used or refenvd to in connection with any offering of
securities by Vickie Mae or any other entity.
A compilation is limited to presenting in the form of projections information that is the
representation of management and does not include evaluation of the support for the
assumptions underiying the projections. We have not examined tiie projections and,
accordingly, do not express an opinion or any other form of assurance on the accomp::nying
statements or assumptions. Furthermore, even if Vickie Mae is established and becomes
operational there will usually be differences between the projected and actual results, because
events and circumstances frequentiy do not occur as expected, and those differences may be
material. We have no responsibility to update this report for events and circumstances
occurring after the date of tills report.
Uotpjt/u^ L uMeu>Ldi LL.P.
New Yortt, New York
June 15, 1995
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67
VENTURE eAHTAL MMVCETIffS ASSOCIATION
(A Proposad Govemmsnt Sponsored Enterprise)
SUMMARY OF SfQMFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES
as of January 1, 1996 (assumed date of Inception)
and fer the flftaen years endlrig December 31 , 2010
1. BUBlnese and Organization
Theee financial projections for the Venture Capital Martceting Association (Vickie Mae), a
Government Sponsored Enterprise (GSE) proposed by the National Association of Small
Business Inve^ment Companies (NASBIC) to t>e established te provide financing to investors
in smell businesses, present, to the best of NASBIC management's Itnowiedge and belief, the
expected assets and liat>llities, results of operations and cash flows of Vickie Mae for the
fifteen years following the inception of Vickie Mae, which is assumed to be January 1 . 1996
(Inception). Accordingly, the financial projections reflect NASBIC management's judgment as
of June 15, 1995, the date of these projections, of the expected conditions and management's
courses of action, assuming that Vickie Mae is established and becomes operational as of
January 1, 1996.
This presentation has been solely prepared to assist Members of Congress, their staff and
other United States Government elficials in evaluating NASBIC's proposal to establish a GSE
such as Vickie Mae. Accordingly, tiis presentation should not t>e used for other purposes,
such as evaluating a potential offering of securities of Vickie Mae.
The assumptions and accounting policies described bek>w are those which management
believes are significant to the projections. There will usually be differences between projected
and actual results, because events and circumstances frequently do not occur as expected,
and those differences may be material.
Vtekie Mae Is a GSE proposed to be fomried for the purpose of providing financing (leverage)
to Snwll Business Investment Companies (SBICs) that have been granted licenses by the
Small Business Adn^nistration (SBA) prior to Inception and by Vickie Mae after Inception.
Vickie Mae will inve^ in both debentures and participating securities of the SBiCs.
Excepit as specifically noted betow, the projections assume that after Inception Vickie Mae's
criteria for licensing SBICs, and the terms of the debentures and participating securities issued
by SAICs, will be similar to those provided for by the Small Business Investment Act of 1956
(the 1958 Act), as amended by the Small Business Equity Enhancement Act of 1992 (the 1992
Act). The 1958 Act and the 1992 Act and related regulations issued thereunder are
collecHvely refeoed to as the Regulations.
2. Capttaltzatton and Rnandng
The Initial shareholders of Vickie Mae will be licensed SBICs. The projections assume that the
shareholders will contribute $20.0 million of equity capital to Vickie Mae at Inception. The
projections also assume that licensed SBICs wfll contribute additional equity capital equal to
1.0% of the private capital and leverage invested in such SBICs after Inception. The
projeotions assume fiat after 1999 Vickie Mae will pay dividends to its shareholders of 20% of
net income, provided that Vickie Mae has positive retained earnings and that payment of the
dhridends wHI not require Vickie Mae to incur additional bonowing.
8
68
VENTURE CAPITAL MARKETING ASSOCIATION
SUMMARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
The debentures and participating securities of SBICs in wtiich Vidde Mae invests wlil be
placed in separate pools, and Viclde Mae will issue certificates of interest in each pool in the
bond market. The proceeds from the issuance of the certificates will be used to finance Viclde
Mae's investments in such debentures and participating securities. Certificates of interest In
the pools of participating securities and debentures are refened to coliectively as Certificates
and, respectively, as Participating Security Certificates and Debenture Certificates.
The projections assume that at Inception the SBA will transfer to Vickie Mae the rights to the
cash flow from $1 85.5 million of outstanding participating securities of SBICs licensed by the
SBA prior to inception: and Vickie Mae will assume an obligation to the SBA to fund principal
and interest payments on an equivalent amount of trust certificates issued by the SBA to
finance its investment in such participating securities.
3. Terms of Viclde Mae Certificates
Vickie Mae Certificates are assumed to be issued at fixed rates of interest with various
maturities of no more than ten years from the date of issuance. The projections assume that
Certificates with less than ten-year maturity may be refinanced and, accordingly, the
projections do not assume any scheduled repayments of Certificates prior to ten years after
original issuance. The projections assume that Vickie Mae Certificates will be callable at face
value beginning three years after issuance. On the basis of the assumptions reflected in the
projections, all Certificates will be repaid prior to ten years after original issuance.
The projections assume that the maritet rate of interest on Certificates with a ten-year maturity
will be the rate on U.S. Treasury obligations of ten-year maturity, plus 0.75% for Participating
Security Certificates and plus 0.65% for Debenture Certificates. The projections assume that
the ten-year U.S. Treasury rate will be 8.0% throughout the projection period. The projections
assume that the effective weighted average interest rate on the Certificates will be 0.25% less
than the rate for Certificates with a ten-year maturity, as a result of financing a portion of the
participating securities and debentures with Certificates of less than ten-year maturity. The
projections assume that only interest will payable prior to maturity of the Certificates.
The projections assume that Vickie Mae will pay a one-time undenwriting fee of 0.625% of
Certiificates' face value when originally issued. The projections do not assume any additional
undeoAfflting fees in connection with the refinancing of Certificates with less than ten-year
maturity.
4. Terms of Participating Securities
The projections assume that the participating securities mature ten years from the date of
issuance and earn a prioritized return equal to the interest rate on Participating Security
Certificates with ten-year maturity, plus 1 .0%. This is a change from the Regulations, which
provide for a prioritized return equal to the interest rate on the Participating Security
Certificates issued to finance the investment in the participating securities.
The prioritized return accumulates from the date of issuance of the participating securities.
SBICs are obligated to make payments of the accumulated prioritized return to Vickie Mae only
69
VENTURE CAPITAL H^ARKETING ASSOCIATION
SUMI^^ARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
out of available cash and only to the extent of accumulated undistributed earnings.
Accumulated unpaid prioritized payments compound at the same rate as the prioritized return.
The projections assume that at the date of issuance SBICs will pay Vickie Mae a one-time user
fee of 2.5% of the face value of participating securities issued. This is a change from the
Regulations, which provide that a user fee of 2.0% be paid to the SBA.
5. Terms of Debentures
Debentures mature ten years from date of issuance and bear interest equal to the interest rate
on Debenture Certificates with ten-year maturity, plus 2.0%. This is a change from the
Regulations, which provide for interest on the debentures equal to the interest rate on
Debenture Certificates issued to finance the investment in the debentures.
The projections assume that at the date of issuance SBICs will pay Vickie Mae a one-time user
fee of 2.5% of the face value of debentures issued. This is a change from the Regulations,
which provide that a user fee of 2.0% be paid to the SBA.
Prior to maturity, only interest is payable on the debentures. The projections assume that
debentures may be refinanced at maturity for one additional ten-year term.
6. Levels of Investment - Participating Securities
The projections assume that as of December 31 , 1994, 19 SBICs were licensed to Issue
participating securities and that the SBA will license 15 additional SBICs in 1995. The
projections assume that after Inception, the number of SBICs licensed to issue participating
securities will be as follows: 15 each year in 1996 and 1997, 12 each year in 1998 through
2000, 10 each year in 2001 through 2006, and 20 each year thereafter throughout the
remainder of the projection period. The assumptions regarding the number of SBICs licensed
to issue participating securities are presented on the face of the projected balance sheets.
The projections assume that $20.0 million of private capital has been or will be committed to
each SBIC that is licensed to issue participating securities. The projections also assume that
the 19 SBICs licensed as of December 31 , 1 994 will invest 20.0% of their committed private
capital each calendar year for 5 years beginning in 1995, and that SBICs licensed after
December 31, 1994 will invest their committed private capital in calendar years as follows:
Year 1 (calendar year of licensure)
10.0%
Year 2
20.0%
Year 3
20.0%
Year 4
20.0%
Year 5
20.0%
Year 6
10.0%
The projections employ a mid-year convention under which it is assumed that the SBICs will
invest private capital as of June 30, beginning in the calendar year of licensure, and will
concuoently issue $1 .75 of participating securities for every SI of private capital Invested.
10
70
VENTURE CAPITAL MAfUCETmG ASSOCtATION
SUMMARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
7. Levels of Investment - Debentures
The projections assume that perfomiing det)enbiFes wi^ a face value of $894 mllHon and
debentures In default or liquidation with a face value of $600 mWlon are outstanding at
Inception. The protections assume thet these debentures wUi not be aoqulrad t>y VicWe Mee,
but that Vickie Mae will be responeiWc for collecting the principel and interest on such
debentures on behalf of the SBA, for which the SBA \wlll pey Vickie Mae a portfotto
management fee as descritrad below in Note 10.
The projections assume that the SBA wW Hcense 1 5 SBICs to issue debentures in 1995 arvj
that after Inception the number of SBICs licensed to issue debentures will be as follows: 15
each year in 1996 and 1997, 12 each year in 1998 through 2000, 10 each year in 2001
through 2005, and 15 each year thereafter throughout the remainder of the projection period.
The assumptions regarding ^e number of SBICs licensed to issue debentures after December
31, 1994 are presented on the face of the projected balance sheets.
The projections assume that $10.0 miltion of private capital will be committed to each SBIC
that Is licensed to issue debentures after December 31, 1994. The projections assume that
these SBICs will invest the same percentages of their committed private capital each year as
SBICs licensed to issue participating securities, and the projections empby the same mid-year
convention regarding the timing of the investment The projections assume that SBICs
licensed to issue debentures will Issue $2 of debentures for every $1 of private capital
Invested.
In addition, the projections assume that in each of 1996 and 1997 Vickie Mae wifl Invest $75.0
million in debentures issued by SBICs licensed prior to December 31 , 1 994.
The pnsjections assume that 60% of the debentures, including the performing debentures
outstanding at Inception, will be refinanced, rather than repaid at maturity. Vickie Mae will
invest in the new debentures that replace those being refinanced.
8. Performance - PartidpaUng Securities
The projections classify the SBICs licensed to issue participating securities Into six
representative categories, with assumed net returns to all investors, including Vickie Mae, after
user fees, management fees and operatir>g costs, ranging from 23.7% to negative 4.4% for
SBICs licensed as of December 31 , 1 994 and from 22.7% to negative 5.1 % for SBICs licensed
thereafter. The assumed weighted average net retum is 1 1.0% for SBICs licensed as of
December 31, 1994, and 10.6% for SBICs licensed thereafter. The projections assume that
the SBICs' Investments in Vickie Mae equity will earn a retum equivalent to the weighted
average net retum on other investnr^nts. Accordingly, the projections assume that net returns
do not require adjustment for the assumption that SBICs will invest 1 % of their capital in Vickie
Mae equity.
The assumptions regarding the weighting factor for each category of SBIC and each
category's net returns and cash distributions are presented in Schedule I for SBICs licensed as
of December 31, 1994 and in Schedule II for SBICs licensed thereafter.
11
71
VENTm« CAPITAL MARKETING ASSOCIATION
SUMMARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
According to the 1994 Investment Benchmark Report published by Venture Economics (the
1994 IBR), the capital weighted net retums to limited partners for venture capital investment
companies formed in 1976 through 1989 were 8.6% for a sample of 84 companies wrtth $50 to
$100 million in capital and 9.0% for a sample of 212 balanced stage companies. After
adjusting the retums reported in the 1994 IBR to eliminate the effects of an assuaged 20.0%
general partners' earned interest, capital weighted net retums to all investors were 10.75% for
companies with $50 to $1 00 million of capital and 1 1 .25% for balanced stage companies.
Management believes that SBiCs licensed to issue participating securities will generally have a
balanced stage Investment strategy and capital, including participating securities, of at least
$50 million.
The projections assume that the SBICs will begin to make cash distributions in the fourth year
after the date of issuance of the participating securities. The projections assume that
distributions will be made on December 31 within the year after the date of issuance for which
the distribution is assumed. Schedule 111 presents, for SBICs licensed after December 31,
1994, the assumed ratios of cumulative distributions to investments for all investors and for
Vickie Mae separately. Distributions from the SBICs to Vickie Mae have been detennined in
accordance with the Regulations, modified as noted above, based on the SBICs assumed net
retums.
Schedule III also presents for comparison the ratios of limited partners' cumulative distributions
to investments for a sample of 403 venture capital investment companies that were fomned
during the years 1969 through 1989, as reported in the 1994 IBR. The ratios have not been
adjusted to eliminate the effects of general partners' carried interests.
9. Performance - Debentures
The projections assume that 20% of debentures will default on interest payments and be
placed in liquidation in the sixth year after the date of issuance. The projections assume that
20% of the principal of debentures placed in liquidation will be collected in the seventh year
after the date of Issuance.
10. Portfblk) Marragement Fees
The projections assume that the SBA or its successor will pay Vickie Mae an annual
management fee of 2% of the average remaining balance of debentures that were outstanding
at Inception. Vickie Mae will not be entitled to a management fee on debentures that refinance
debentures outstanding at Inception.
The projections assume that the SBA will also pay Vickie Mae an incentive fee of 10% of
amounts coHected on debentures that were Hi default or in liquidation at Inception. The
projectior» assume that 50% of the principal amount of such debentures will be collected in
total, and that collections will occur in equal amounts in each of the first five years following
Inception.
12
72
VENTURE CAPITAL lylARKETING ASSOCIATION
SUMMARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
11. Cash Management
Vickie Mae is assumed to pay interest cun-ently on Participating Securities Certificates, wtiile
distributions from the underlying participating securities are assumed to begin four years after
issuance. Accordingly, cash received by Vidcie Mae from SBIC equity capital contributions,
distributions on participating securities, interest on debentures, management fees and other
sources may not be sufficient to pay interest on the Certificates and current operating
expenses, particularly in the first years following Inception. In such a case, It is assumed that
Vickie Mae will finance cash requirements with short-term borrowings at interest rates
equivalent to the rate on U.S. Treasury obligations of three-year maturity, plus 0.50%. On the
basis of the assumptions reflected in the projections, no short-term borrowings are required.
To the extent that Vickie Mae has excess cash, the projections assume that Vickie Mae will
maintain a cash balance at year end of $50 million. The projections assume that cash
available in excess of the assumed year-end balance will be used to redeem Certificates called
by Vickie Mae prior to maturity. Redemptions are allocated between Participating Security
Certificates and Debenture Certificates on the basis of the cash flow attiibutable to the
participating security and debenture segments of Vickie Mae. Summarized projected income
and cash flow statements for the participating security and debenture segments of Vickie Mae
are presented in Schedules IV and V, respectively.
The projections assume that Idle cash will earn Interest at the rate of 4% per year.
12. Operating Revenue and Expenses
The projections assume that Vickie Mae will charge license applicants a nonrefundable
application fee of $5,000. The projections assume that one-half of applicants will be granted
licenses as SBICs.
The projections assume that Vickie Mae will charge all licensed SBICs an annual examination
fee of $5,000, equal to Vickie Mae's cost of performing such examinations.
The projections assume that Vickie Mae's general and administrative expenses in the first year
after Inception will be $5.75 million, approximately equal to the cun-ent budget of the
Investment Division of the SBA. The projections assume that ttie amount of such expenses
will grow at 5% annually throughout the projection period.
13. Capital Expenditures
The projections assume that capital expenditures for furniture, computers and other office
equipment, and leasehold improvements required at Inception will be $2.2 million. After
Inception, the projections assume that annual capital expenditures will be $440,000 throughout
tiie projection period.
The projections assume that fixed assets are depreciated over ten years using tiie straight line
method.
13
73
VE^^^JRE capital marketing association
SUMMARY OF SIGNIFICANT PROJECTION ASSUMPTIONS
AND ACCOUNTING POLICIES (continued)
14. Accounting Policies
The eccompanying projections have been prepared using the accnjal method of accounting In
accordance with generally accepted accounting principles. Significant accounting policies are
descrit>ed below.
Revenue from prioritized returns on participating securities of SBICs is recognized when
received In cash, because SBICs are not obligated to make prioritized payments except from
undistributed earnings, which can not be assured.
User fees received from SBICs in connection with Vickie Mae's investments in participating
securities and debentures are deferred and recognized as revenue using the straight line
method over ten years, the maturity period of the participating securities and debentures.
Underwriting fees paid in connection with the issuance of Certificates are deferred and
recognized as expense using the sti^ight line method over ten years, the effective maturity of
the Certificates.
The use of the sti3ight line method for recognizing user fee revenue and underwriting fee
expense does not yield a materially different net result from use of the interest or effective yield
method.
A provision for losses on debentures, net of assumed recoveries, is accrued at the time when
such losses are probable and estimable, which is assumed to be in the year of default on
interest payments.
15. Income Taxes
The projections assume that all SBICs will be organized in the form of limited partnerships and,
accordingly, will not be subject to income taxes. The projections assume that Vickie Mae will
be subject to U.S. federal but not state and local income taxes. The projections assume that
the effective U.S. federal income tax rate is 35% and that there are no differences between
income reported for financial reporting purposes and tax purposes.
The projections assume use of net operating loss (NOL) carrybacks and carryfonvards. The
tax benefits of NOL canvfonvards are recognized in the pnsjections when realized for tax
purposes.
14
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81
STATEMENT
OF
JAMES E, MURRAY
BEFORE THE SUBCOMMFFTEE ON
GOVERNMENT PROGRAMS OF THE
HOUSE COMMITTEE ON SMALL BUSINESS
Mr. Chairman and Members of the Subcommittee on Government Programs of the House
Committee on Small Business:
Thank you for the invitation to appear before this Committee and to submit a
statement on H.R. 2806, a bill to create the Venture Capital Marketing Association ("Vickie
Mae"). I am James E. Murray, counsel in the Washington, D.C. office of the law firm of
Brown & Wood.
My background in government-sponsored corporations or enterprises ("GSEs"),
particularly those engaged in secondary market activities, is as follows. From May, 1970
until May, 1981, I served as Vice President (and later Senior Vice President) and General
Counsel of the Federal National Mortgage Association ("Fannie Mae"). From May, 1981,
until January, 1983, I was President of Fannie Mae.
During 1971 and 1972, I assisted the Student Loan Marketing Association ("Sallie
Mae") in the formulation and implementation of the legislation which created Sallie Mae.
In 1987 through 1988, I represented the American Bankers Association in seeking the
creation of an agricultural mortgage loan secondary market. This effort culminated in
legislation enacted by the Congress in 1988-' which created the Federal Agricultural
Mortgage Corporation ("Farmer Mac"), charged with the task of creating a secondary market
for agricultural real estate loans.
- Agricultural Credit Act of 1987, Pub. L. No. 100-233. 101 Stat. 1568.
11292.1
82
The Government-Sponsored Enterprises in the Secondary Markets
Enclosed as exhibits A and B to my statement are two charts which compare the legal
and organizational characteristics of the GSEs and Vickie Mae, as envisioned by H.R. 2806.
The charts illustrate that the legal and organizational characteristics, and the relationships of
Vickie Mae to the Federal Government, are well within the norms established by the other
GSEs.
Characteristics of Government-Sponsored Enterprises
All of the GSEs have certain legal characteristics which distinguish them from truly
private corporations. The most important is the authority of the corporation to borrow from
the U.S. Department of Treasury. Under Section 354 of H.R. 2806, the Secretary of the
Treasury is authorized to purchase up to $1 billion in Vickie Mae securities. The financial
markets do not give great weight to the amount of the authority, but rather the mere fact of
its existence. In the case of Fannie Mae, for example, the authority of the Secretary of the
Treasury is limited to $2.25 billion. This is the same amount which was contained in the
Fannie Mae Charter Act in 1968, even though Fannie Mae has grown from $8 billion to over
$200 billion.
Another important characteristic of the GSEs is contained in Section 355 of H.R.
2806. The section permits national banks, federally chartered S&Ls and federal credit
unions to invest in the stock and obligations of Vickie Mae.
83
Vickie Mae Will Be More Efficient and Effective than SBA
The GSEs engaged in secondary Harket activities have been created by the Congress
to carry out activities determined to be in the national interest in the private sector. Whether
in housing through Fannie Mae, Ginnie Mae and Freddie Mac; student loans through Sallie
Mae; or farming through Farmer Mac, the United States Congress has made the policy
decision that these corporations' activities in the secondary market can more properly be
performed as private corporations, owned and controlled by their stockholders. Clearly, the
same determination can be made in the case of Vickie Mae. This legislation must be
premised upon a decision by the Congress that it would be a significant improvement to the
condition of the small business community to transfer certain of the activities performed by
the Small Business Administration into the private sector.
Additional Capital Attracted to Small Business Investments
One of the primary reasons for creating GSEs in secondary markets is to provide
additional liquidity and attract new capital into a particular segment of the economy. This
has been abundantly proven to be the case in the residential mortgage and the student loan
markets.
Greater Ability to Adapt to Changing Financial Markets
In recent years, the financial markets have undergone significant changes. The
methods of providing capital for housing for example, have changed dramatically as the
instimtions of the Federal Home Loan Bank System have experienced financial difficulties.
The GSEs in the secondary markets have demonstrated an ability to adapt rapidly to changes
84
in the primary markets. As private corporations, without undue government regulation, they
have been permitted to move expeditiously to accommodate these changes.
Self-sustaining and Profitable
Government-sponsored corporations must be self-sustaining, which means that they
must be profitable and able to obtain and attract new capital. In order to be self-sustaining,
the GSEs must operate in the private sector in the most efficient manner possible to obtain
the return on capital sufficient to maintain and attract additional capital.
85
EXHIBIT A
Govemmem Sponsored Enterprises -
Summary of Legal Characteristics
Freddie Fannie Sallie
Mac*" Mae'' Mae
Farmer
Mac
Vickie
Mae
Issuing authority under an Act of Congress
XXX
X
X
Exempt from SEC registration
XXX
X
X
Legal investment for National Banks, Federally
Chartered S&Ls, and Federal Credit Unions
XXX
X
X
Issuable and payable through facilities of the Federal
Reserve Bank
XXX
X
X
Eligible collateral for Federal Reserve Bank advances
and discoimts
XXX
X
X
Public securities eligible to be purchased and held
without limitation by National Banks
XXX
X
X
Supported by an authority to borrow from the U.S.
Treasury Department
XXX
X
X
Obligations exempt from state and local income
taxation
X
Issuance only upon approval by the U.S. Treasury
Department
X X
X
Backed by full faith and credit of the U.S.
Eligible as collateral for Treasury tax and loan
accounts
XXX
X
X
Eligible to open market purchases
XXX
X
X
Eligible for National Bank repos without reserve
requirements
XXX
X
X
Eligible for private repos (outside the margin rules)
This chart is a summary only.
Both debt and guaranteed mortgage pass-through securities.
86
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87
N A S B I C
NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES
1 199 N. Fairfax Street • Suite 200 • Alexandria. VA 22314 • Tel; (703) 683-1601 • FAX: (703) 683-1605
OFFICERS
• KEfTH R. FOX
E»e«f Venture Lenden. LP
Nw Yori^ VY
ChMirMtn-Vat
• HAKVEY CRANAT
Srerbng ConuiwnuJ QpiUL Inc
Crwi \«k. VY
• CW DICK
Pioneer Ventures. LP
Boston. MA
Statement
of
Raymond R. RafFerty, Jr.
BOARD OF GOniLSORS
The Officen and
THOSUS )- ADAMEK
Pnmier Venture CjpiUl Corp
National Association
Of
Small Business Investment Companies
MICaULF.ELUOTT
SatwroBdni Lewnged Cipro I Croup
PitTjbKjr^h. PA
PALIHKEILEY
lim Staee Opit^
Cimbnoge. \\.\
RICHARD C KLyTKY
A EngLunl Qpital
LP
Hift'ord. a
FRAMC R. KUNE
Klme Hjwkts Catomu SBIC, LP
Liw Angdes. CA
THOMAS E. LOEHR
Fourth Ventxire Investment Croup, Ir
Cturlrttoiv V,y
L RAY MONCIUEF
Vbuniain Ventures, Inc.
before the
Committee on Small Business
Subcommittee on Government Programs
United States House of Representatives
• lAMES A- PARSONS
RfE Investmrnt ?u^m
\iv, Caiuan. CT
• R.«\IOND R. RAFFIRTY. )R.
Radnor. PA
MLLUMREISLER
fLiniis Cit\' Equjty Pirtners
Prajne ^ibgt, KS
JOHNCHllSSm
Anthem QpiUl. LP
■dinmore, MD
HOMAS WESTIROOK
Allied Cipil^ Adi-iser^. IrK
WjihingWn. DC
JOHN P. WHALFY
^l)^*rtt\iEB^UrtC^p1Ul
Minneapolis. MN
LhlTTE
CjpitaL LLC
April 18, 1996
88
Mr. Chairman and members of the Subcommittee:
I appreciate the opportunity to testify on H.R. 2806, the Venture Capital Marketing Association
Charter Act. I am a General Partner of Meridian Venture Partners, an SBIC located in Radnor,
Pennsylvania. Meridian has $45 million under management. Meridian was the first institutional
investor to finance Mothers Work, NASBIC's 1995 Portfolio Company of the Year. Mothers
Work is now a publicly held specialty retailer employing over 2,000 people in a network of 455
retail stores in 43 states. It is truly a great example of what the SBIC program can accomplish.
As my colleague Mr. Dunbar has done, I commend Chairman Torkildsen for introducing this
legislation. I am firmly of the opinion that creating Vickie Mae is one of the single greatest steps
Congress could take in helping the small business base of America. That such a result could be
brought about while at the same time improving the safety and soundness of the program, reducing
the size and cost of the Government, and moving the program one step closer to full privatization
demonstrates the real power of the Government Sponsored Enterprise approach. In this regard,
and as a member of the National Association of Small Business Investment Companies, I endorse
the points that Mr. Dunbar makes in his testimony.
Mr. Chairman, you have asked me in my capacity as a General Partner of an active SBIC to
comment specifically on the advantages or opportunities that might be made available to me,
particularly in the area of participating securities if your bill were enacted. I am happy to do so.
There are two significant advantages (leading to opportunities) that I, as a managing partner of an
SBIC, would have that I do not have under the current program. I believe that all managers of
active SBICs would concur with the points I will make.
1. Advantages
• The creation of Vickie Mae should result in the enhanced performance of my
fund and thus provide greater returns to my investors, including Vicltie Mae
in the case of participating securities, and make Vickie Mae stronger.
• The creation of Vickie Mae should make more money available to more small
businesses by increasing the universe of potential private investors and
making it more likely that I would be able to start a new fund or attract
additional capital to my existing fund.
89
2. Discussion
Vickie Mae would give me confidence that I would have a stable flow of leverage capital, subject
only to conditions of the private capital markets (something we all live with) and not to the vagaries
of the political process. Vickie Mae would ensure our leverage through a normal investment cycle
of between five and seven years. This is particularly important with respect to planning for any
follow-on investments that might be advisable with respect to any of our portfolio companies.
As a result of this ensured leverage capital over the course of my normal investment cycle, I would
be better able to plan and manage my fund. That should result in enhanced performance of my
fund and thus greater returns to my investors, including Vickie Mae in the case of participating
securities. This latter result is particularly important. By increasing Vickie Mae's returns, the
organization would grow in strength. Not only would that aid in the sale of Vickie Mae's
securities, but it would increase the likelihood of Vickie Mae's full privatization in the future.
The second and related advantage is the increased confidence that my required initial private
investors would have in the SBIC program in general and thus in my fund as well, whether a new
or existing fund. My business plan is built on the assumption that I will be able to draw down the
maximum leverage capital provided for in the legislation. If that leverage capital is not certain, my
private investors are less likely to agree to initially invest their money and less likely to add
additional private capital if my fund were already in existence.
Because of the increased investor confidence, Vickie Mae would increase the universe of potential
private investors and make it more likely that I would be able to start a new fund or attract
additional capital to an existing fund. This would provide me and other professional SBIC
managers great advantage and opportunity. It would provide great advantage and opportunity to
the U.S. small business community we serve by making more investment money available.
In the final analysis, the SBIC program is successful because the small businesses we invest in are
successful. It is generally accepted that more small businesses fail for lack of capital than any other
reason. The more we can do to address the lack of capital problem, the better we will be as a
nation.' I believe the legislation you have introduced will make the SBIC program a substantially
better program in providing that capital to a greater number of worthy small businesses.
Thank you again for the opportunity to present my views.
BOSTON PUBLIC LIBRARY
lllllilll
90
3 9999 06350 070 4
Oral Testimony of Joel Ze£art, President
of JBS A Auociatca, Inc.
Thank you for the opportunity to present testimony at this hearing on IIR2806. By way
of Introduction, my name is Joel Zegart and 1 am president of JBS & Associates, Inc. - a
Chicago based loan sale advisory and asset disposition firm. Since the inception of our
firm in 198S, we have sold nearly 3 billion dollars in assets for governmental agencies
such as the RTC, FDIC, Ginnie Mae and HUD.
I am here to address one topic that has not received much attention in the prop<ised
legislation; the liquidation of defaulted SBA guaranteed loans and failed SBICs.
Obviously, in these times ol" budgetary crisis, a well-conceived and effective disposition
strategy that maximizes recovery is vitally important to the US taxpayer.
JBS & Associates conducted the first loan auction for the RTC in June of 1991. We
conducted several more loan auctions for the RTC during its tenure including the largest
loan auction ever conducted at that time with over 700 million dollars in loans being sold
over a two-day period in August of 1993.
After having observed the maturing of the maricet for non-performing loans, we are
convinced that there will also develop an orderly, efficient maricet for the loans
guaranteed by the SBA. We witnessed the tremendous investor interest (hat developed
around the RTC loan sales - with each loan sale attracting more and more investors. All
types of investors from banks and investment banking firms to small entrepreneurial
groups and investment funds quickly sprang up to take advantage of the new investment
opportunity.
Because the RTC loan sales program was conducted in an iterative competitive bid
format, these investors were forced to bid openly against each other and such bidding
drove prices up to market levels. Very quickly, this market matured and the pricing
became very efficient using this sale method. Frequently, we now hear that some buyers
of this product do not want to compete in competitive bid sale.*: because the prices have
gotten so high and they would much prefer the privately negotiated sale since they can
get a better price.
One particular aspect of this loan auction program that 1 would like to discu&s is the use
of computer imaging technology to present loan information and documentation for
investor review. Having seen first hand the problems with investor due diligence with
hard copy of loan files - the boxes and boxes of paper, maintaining the integrity of the
files after investors have rifled through documenLs and sometimes purposely misplacing
important papers to the disadvantage of other bidders - we realized that there had to be a
better way to conduct investor due-diligence, liven microfilming the documents created
problems as investors were literally getting seasick fix)m spending a day watching
microfilm loan documents speed by on the screen in fmnt of them.
91
After researching the problem, we esUbJished a pilot profram for one RTC loan auction
that utilized a state-of-the-art computer imaging sysrtem that allowed investors to review
and access loan documents from individual computer workstations. This new system was
immediately well-received and quickly became the model for investor duc-diligcncc at all
future RTC loan sales.
For die RTC, we scanned and indexed over 1 0 million loan documents Tor investors to
review on a network of up to 200 computer workstations. The system worked well for
investors as thty were able to comfortably review documents simultaneously so that all
investors competed on an even playing field.
JBS has since expanded the scope of loan file review by introducing CD-ROM
technology enabling investors to review complete loan documents in the comfort of their
own offices without incurring the expense of traveling to a "duc-diligcncc" war room in a
distant city.
We believe that this new loan file "due-diligcncc" utilizing CD-ROM technology greatly
iHvadens the universe of investors who now have the time to review more loan packages
and prepare bids for competitive bid sales, lliis technology is al.so currently being used
in the ongoing HUD mortgage loan sale program and has been instrumental in the success
of these sales in expanding participation by investors and generating more bidders at the
day of sale.
Although we recognize that the SBA loans probably do not possess the same
homogeneity as RTC single family mortgage lo«is or HUD mortgage loans, wc feel that
the disposition program will also work for assorted small commercial business kians such
as those made by the SBA. We recently conducted an auction of a loan portfolio for a
major midwestem bank that was comprised of small and varied commercial business
loans of a kind similar to those made by the SBA. This sale of a relatively small portfolio
attracted 29 different bidders and was one of our most successful loan auctions. Wc
utilized the CD-ROM technology for this sale vtiiich greatly broadened the universe of
investors as many of the investors were able to perform tl^ir due diligence without
leaving their ofiBces on the east or west coast.
We also feel that there would be a strong appetite among investors for selling not only
individual assets and loan portfolios but selling in bulk entire small business investment
companies (SBICs) that have failed. Rather than selling the assets of the SBIC
piecemeal, we believe a timely sale of the whole company would capture additional
franchise value that would otherwise be lost in liquidation of only the firm's portfolio of
individual assets.
For these sales of SBTCs, all of the pertinent financial information, records, reports and
all relevant operating statements on the company could be imaged and indexed so that the
entire "due-diligence" package would be available to potential investors on CD-ROM.
As an example, a sale that we conducted for a shopping mall in Indianapolis pioneered
92
the use of a multi-media CD-ROM to provide investors a virtual walk-through of a
commercial real estate property. With a well-orchestrated marketing plan and the
convenience of CD-ROM duc-<liligencc, an iterative form of a structured competitive-hid
sale should attrnct many bidders so that the SBIC would trade at a level approximating
fair market value.
We believe that a program utilizing imaging technology to expand the universe of
potential bidders and make it easier and less costly for investors to review assets
combined with an iterative form of competitive bidding would provide an efficient
mechanism for liquidating SRA guaranteed or owned assets.
Currently, the SBA is not utilising such a program and is generally involved in long
protracted negotiations in selling off assets aAer loan defaults and foreclosures.
Unfortunately, time is the enemy in these cases and the assets generally deteriorate over
lime and lose value. Generally, the SBA would be much better off realizing the present
value of these defaulted assets through a well-marketed competitive-bid sale.
Rather than being swamped with an ever increasing inventory of deteriorating assets,
utilization of a competitive bid sale program and outsourcing the disposition
responsibility to the private sector would relieve the stafl" of the SBA of the burden of
managing and servicing these assets and more expeditiously convert these assets into
revenue for the government.
o
ISBN 0-16-053420-8
9 780160"534201
90000
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