By 2006, new secondary-market dollar volume for 7(a) loans had risen to a record high of $4.6 billion. Conventional, non-SBA-secured small business loan securitizations were growing at a moderate pace, although at a much smaller rate than that of SBA- backed loans. In late 2008, the secondary market for small business loans slowed substantially. The top two issuers of small business loan ABS—Lehman Brothers Small Business Finance and Ciena Capi- tal—both filed for bankruptcy earlier in the year. In addition, Bayview Financial, another large player in the market, closed down its securitization operations in 2008.
SBA 7(a) Loans
Historically, most of the small business loans that have been securitized involved the guaranteed por- tion of loans made under the SBA’s 7(a) Loan Pro- gram. These securitizations have been fairly common because they do not involve the risk and information impediments typically associated with the securitiza- tion of small business loans. SBA 7(a) loans tend to be highly standardized because the underlying loans are often backed by similar types of collateral and loan documentation. In addition, the originators are SBA “preferred lenders” and are perceived to have clear and rigorous underwriting standards that are consistently applied. Despite this preferred status, the SBA secondary market also dropped off substantially in September 2008.
As the secondary markets froze and regulators attempted to restore financial stability, several actions were undertaken, with important implications for the SBA 7(a) secondary market:
75Although credit scoring has the potential to increase the unifor-
mity of underwriting procedures and standards for small busi- ness loans, thereby expanding access to secondary markets, Cowan and Cowan (2006, p. viii) report that “there is no indica- tion of any momentum in the development of secondary mar- kets for small business loans.” Their survey finds that respon- dents generally did not view secondary-market sales as an important reason for adopting small business credit scoring.
November 2008.As financial markets became more
globalized, increasing shares of SBA lenders’ cost of funds became tied to the London interbank offered rate (LIBOR). In a more stable financial environ- ment, the LIBOR was consistently 3 percentage points lower than the prime rate, which was the rate required to price 7(a) loans. However, as the financial markets became increasingly volatile, the spread was reduced, thereby reducing the profitability of SBA loans. This reduction in turn led to increased diffi- culty in selling the loans on the secondary market. In order to reduce some of the risk and uncertainty to lenders, the SBA began allowing lenders to price loans based on the LIBOR rather than requiring the prime rate (U.S. Small Business Administration, 2008a). Around the same time, the SBA also
announced that it would allow weighted-average cou- pon pools in order to make the SBA pools more attractive and more consistent with other types of securities sold on the secondary market (U.S. Small Business Administration, 2008b).
2008–09.The Federal Reserve established the Term Asset-Backed Securities Loan Facility (TALF) to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more-normal interest rate spreads. The facility was announced on Novem- ber 25, 2008, and began lending operations in March 2009. TALF lending was authorized through June 30, 2010, for loans collateralized by newly issued commercial mortgage-backed securities and through March 31, 2010, for loans collateralized by all other TALF-eligible securities.76Between March 2009 and June 2010, the Federal Reserve lent a total of $71.1 billion, $2.2 billion of which went toward SBA loans.
June 2009.The Financial Accounting Standards Board announced two new provisions (Statements of Financial Accounting Standards Nos. 166 and 167) intended to provide increased transparency for inves- tors about a company’s risks. In effect, the new provi- sions required that banks that sold the guaranteed portion of their 7(a) loans on the secondary market have to defer recognizing the income until after the 90-day warranty period required by the SBA. In addition, regulatory capital must be held until the sale can be recognized. Banks argued that these
requirements made the income from servicing the loan more attractive than reselling it and reduced sec- ondary market sales. In January 2011, the SBA removed the 90-day recourse period from the stan- dard secondary-market agreement, allowing banks to recognize the income when the sale occurs.
As seen infigure 13, the secondary market for SBA 7(a) loans experienced a great deal of volatility over the past five years. Prior to September 2008, an aver- age of $328 million settled in the secondary market each month. Between October 2008 and May 2009, less than $200 million settled each month. By mid- 2009, average monthly settlements had returned to their previous levels. Settlements rose again through- out 2011, reflecting the record-high dollar volume of 7(a) loans approved with the increased funding from ARRA and the Small Business Jobs Act.
A similar pattern can be seen in looking at pricing premiums over this period. Because the guaranteed portion of the 7(a) loan is secured by the full faith and credit of the U.S. government, the loan is gener- ally sold at a significant premium. During the peak of the crisis, a large fraction of the loans that were able to be resold in the secondary markets were sold at premiums at or below 103. By December 2009, the majority of loans were sold at or above a premium of 106—the prevailing premium level in 2007. Into 2010 and 2011, a growing portion of loans were being sold at or above a premium of 110, indicating investors’ preference for a relatively low-risk asset.
Looking forward, the secondary market for 7(a) SBA loans appears to be healthy and operating well. With no programmatic changes in the foreseeable future, the market should continue to move along smoothly at current levels.
SBA 504 Loans
The other large loan program from the SBA is the 504 program, which primarily finances real estate. As noted earlier, 504 loans are typically funded through a combination of funds from a private lending insti- tution, the SBA CDC, and the business owner. CDCs assist small business borrowers in preparing and sub- mitting the SBA 504 loan applications. The deben- tures are packaged with other debentures into a national pool and sold monthly to investors. As the traditional markets become more volatile, the demand for these safe investments generally increases.
76For more information on the TALF, see the Federal Reserve
Board’s website atwww.federalreserve.gov/newsevents/reform_ talf.htm.
Figure 13. Small Business Administration secondary market, 2000–12 0 100 200 300 400 500 600 Millions of dollars 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
A. 7(a) settled value
0 20 40 60 80 100 Percent 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
B. 7(a) premium ranges
Between 103 and 106 103 or below 106 or above 100 200 300 400 500 Millions of dollars 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 C. 504 debentures volume
Note: Three-month moving average.
Source: Data provided by Small Business Administration, Office of Financial Assistance.
Mar.
Mar.
Apr.
As a provision of ARRA, a new program was cre- ated to encourage sales into the secondary market of the “first mortgage” portion of 504 loans. Under the new program, portions of eligible 504 first mortgages pooled by originators or broker–dealers could be sold with an SBA guarantee to third-party investors in the secondary market. Lenders will retain at least 15 per- cent of each individual loan, pool originators will assume 5 percent of the risk, and the SBA will guar- antee the remaining 80 percent. To be eligible to be included in a pool, the first mortgage must be associ- ated with a 504 loan disbursed on or after Febru- ary 17, 2009.
As seen in panel C of figure 13, the secondary vol- ume for 504 debentures dropped off significantly in late 2008. It remained relatively flat throughout 2009 and 2010. Since 2011, it has been rapidly climbing but has not yet reached its peak level of 2007–08. With the first mortgage program, volumes are likely to increase throughout 2012 and then level out going forward.
Non-SBA Loans
With the bankruptcy of Lehman Brothers and Ciena Capital, new issuance of small business ABS not backed by an SBA guarantee has been quite limited since 2008. In its latest outlook for the small business loans ABS market, Moody’s Investors Service fore- casts that securitizations of these assets will remain “stressed” throughout 2012.77