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Letters to Regulators
USDA's Rural Business Investment Program
July 8, 2004
Ms. Cheryl Thompson, Management Analyst
RE: RBS's Rural Business Investment Program Regulation; Interim Final Rule - RIN 0570-AA35
Dear Ms. Thompson:
We are sending this letter on behalf of the Independent Community Bankers of America (ICBA) and its nearly 5,000 community bank members. ICBA is the largest national banking trade association and exclusively represents the interests of the nation's community banks. Our comments pertain to the Rural Business-Cooperative Service (RBS) request for comments regarding the interim final rule for the Rural Business Investment Program (RBIP).
Background: RBIP Interim Final Rule
The RBS has asked for responses to an interim final rule published June 8, 2004 in the Federal Register that implements the RBIP, which was created by Section 6029 of the Farm Security and Rural Investment Act of 2002 (Farm Bill). This rule adds Part 4290 to Title 7 of the Code of Federal Regulations that governs the operation of the Small Business Administration's (SBA) Small Business Investment Company (SBIC) program. The RBIP was developed with the goal that it would operate similar to the SBIC, except with a focus on rural areas. The RBIP is designed to promote economic development and create wealth and job opportunities in rural areas by licensing Rural Business Investment Companies (RBIC) that will make venture capital investments in entities located in rural areas. We appreciate the agency seeking public comments and beginning the implementation of this program, which was authorized in the 2002 Farm Bill. The Farm Bill requires the USDA to enter into an interagency agreement with another Federal agency that will operate the RBIP, which is the SBA.
ICBA Comments and Concerns
As noted, the RBIP was created with the goal of attracting venture capital investments to rural America. The statute was designed with several key provisions that would encourage such investments. First, the program was to allow RBICs to form with a minimum of $2.5 million in regulatory capital with the approval of the Secretary of Agriculture, but this interim final rule requires a minimum capital level of $10 million.
Capital Requirements - We believe $10 million is an unnecessarily high level of capital for many entities that could be formed to effectively serve rural areas. Given the difficulty of raising capital in rural areas, the RBIP should provide greater flexibility than the SBIC program, which can raise funds much easier for financing projects in heavily populated urban areas.
Additionally, we question why USDA would issue a Notice of Funds Availability (NOFA) on June 8, 2004 that proposes to only license up to three RBICs for the 2005 fiscal year. If the program is going to be restricted by limited funding, we suggest it would be more effective to license more RBICs with less regulatory capital ($5 million+), but provide the 300% leverage as authorized in the statute.
Acquiring a $10 million capital level will not determine a RBICs ultimate success or failure. Rather, USDA and SBA should focus on whether the proposed RBIC has qualified management in place. Many projects in smaller areas can be financed with smaller amounts of capital than what SBICs are accustomed to for urban areas.
Further, in its NOFA, USDA states that there will be no exceptions to the $10 million private equity capital requirement. This is inconsistent with the statute, which specifically allows exceptions for entities capitalized at $2.5 million. With limited funding available for the program, more RBICs with smaller capitalization requirements could be financed if this requirement were loosened.
The RBIP was created with input from a number of diverse groups and entities and holds a great deal of potential for bringing important private investment capital to rural areas, just as the SBIC program has for urban areas. However, this regulation raises obstacles that will only serve to complicate and frustrate the process for applying for a RBIC license, and in fact, will discourage a majority of potential licensees from even applying, given the difficulty the regulation would pose for those trying to raise the required capital for eligibility.
Leverage Levels - Furthermore, the RBIP was authorized with a 300% debenture guarantee of the regulatory capital level compared with a 200% guarantee for the SBIC. This was yet another incentive that was built into the program that would encourage the formation of entities with the focus of bringing greater private investment capital to rural regions. USDA does not explain why it chose to forgo a 300% leverage limit as authorized in the Farm Bill.
Type of Financing - Also, the rule outlines the types of financing that a RBIC is eligible to offer, including purchasing equity securities, purchasing debt securities, purchasing securities from a third party, offering guarantees, and loans. The regulation stipulates that a loan can only be made with a maturity of five years or less and only if it is determined that making the loan is necessary to preserve existing financing, other than a loan, in the enterprise.
Generally, we have had concerns that the RBIC not be subsidized debt lenders competing with commercial banks by providing loans commercial banks would otherwise provide. We believe this is what the statute was seeking to reflect. We also recognize that there may be times when loans could be provided if the loans have an equity upside, meaning equity kickers such as options or royalties on sales and so forth.
Loans with equity upside may be quite useful for this program and this is, from our understanding, consistent with what SBA's experience has been in terms of successful SBICs versus unsuccessful ones. If the regulations allowed loans with equity upside, as long as the regulations require proof that two commercial lenders (this should not always be the same two lenders) have turned down the loans on the same terms, this would ensure that the loans are non-bankable at the outset and would not raise subsidized competition issues. There would need to be adequate transparency about these types of activities so that the program is not turned into a subsidized lending program that competes against the private sector. The state of Michigan's BIDCO program had similar regulations.
Rural Area Definition - The rule defines a "rural area" as located outside a metropolitan statistical area or within a community with a population of 50,000 people or less. In addition, RBICs are required to invest at least 75% of financings in rural business concerns located in rural areas. However, only using the 50,000 population cap as a guideline would allow inclusion of a number of suburban areas, and since the goal of fund managers is going to be to increase the return on investment, a majority of the funding could flow to the heavily populated areas, leaving the "real" rural areas with little or no additional investments. As such, we would recommend the agency reevaluate the criteria used to determine what would define a rural area for purposes of this program. Criteria should ensure that the majority of funding flows to businesses in truly rural areas that are at the greatest disadvantage for attracting outside investment. The agency should consider giving a higher ranking to RBIC applicants in the licensing process that propose to serve rural areas without significant population centers or rural populations of 20,000 people or less.
RBIC Charters - Moreover, we believe there should be some limitation or restriction that would prevent current SBICs from converting to a RBIC simply for the purpose of tapping additional funding sources to continue providing investment capital to the same areas and perhaps even the same businesses it is currently serving as a SBIC. The RBIP must be clearly focused on providing equity capital for rural America and not become an extension of an institution's existing SBIC program.
Agency Imposed Fees - In addition, the rule requires applicants for a RBIC license to pay a $5,000 grant issuance fee when the license application is submitted. The fee amount seems unnecessary, but at the very least, it should be refunded to the applicant if the license is not approved. Also, the annual examination fees that are outlined in the rule appear excessive. The $9,200 base exam fee for RBICs is approximately the same amount charged in the SBIC program for a SBIC with $25 to $50 million in total assets. Why should the base exam fee for RBICs be so much higher than for SBICs? These extreme fees will only serve to further discourage participation in the RBIP.
RBIC Fees - It is realistic to allow RBICs to charge a loan commitment fee prior to closing the loan. Also it is sensible to allow RBICs to charge a reasonable amount relative to the complexity of a deal for due diligence. Such fees can offset the cost of overhead, which will be proportionally greater with a smaller fund that has less equity, but allowance to charge fees should be weighed against the receipt of grant money for operational assistance, which could mitigate against the need to charge fees to each applicant and/or could lower the amount of fees assessed. There could be some criticism of the program if every applicant is charged a 1% fee while at the same time the RBIC receives $1 million in operational assistance. USDA regulations should address these issues without unduly penalizing the RBIC or applicant.
Reporting Requirements - As a means to ensure transparency and public accountability, USDA or SBA should make information publicly available regarding the RBIP. This information should include how many RBIC licenses have been issued; the names of RBICs currently operating; what types of projects are being funded, and whether any RBICs have extended loans including the amount, purpose, and an explanation of whether a commercial bank was solicited for providing the loan. In addition, the report should include a general analysis of the economic impact each RBIC is having in its operating area, whether it is meeting its goals laid out in its application and whether new jobs or value added agricultural benefits have been created.
While we understand this is an interim final rule that has already gone into effect, we recommend that the agency withdraw the rule or substantially rewrite it to address the concerns we have raised. The agency should reevaluate the rule, and in particular, consider the impact that such inflexible regulations will have on the ability of entities to participate in the RBIP due to unnecessarily high capital requirements. The agency has not explained why new entities would seek a RBIC license requiring them to operate in primarily rural areas when they can more easily obtain a SBIC license to operate in any area.
This program was created with the goal of encouraging more private capital investment in rural America. Unfortunately, the interim final rule issued by RBS does not provide the necessary incentives, some of which are clearly stated in the statute, to encourage participation in this program. As written, it is likely to result in few RBICs being licensed. This would be an unfortunate outcome for rural America and all of the businesses and individuals that could be positively impacted if a more flexible RBIP were successfully implemented. If USDA and SBA pursue a very restrictive program that eliminates the possibility of well- managed, smaller entities being formed as RBICs, and that caters to large institutions only, it is very likely that support for the program and its appropriation levels will diminish considerably among many current supporters of the program.
Thank you again for the opportunity to provide our views on this issue. If you have any questions about this comment letter or would like to further discuss any of these concerns, please contact Mark Scanlan, Director, Office of Agriculture and Rural Policy or Reece Langley, Deputy Director, Office of Agriculture and Rural Policy at 202-659-8111.
Camden R. Fine