Commercial banks, still busy with the business of tidying up their portfolios and shrinking balance sheets, are slowly getting back to small business lending. However, the void created by their long absence has been increasingly filled by both smaller regional banks and nonbank lenders. It's the latter that are driving securitization because it increases their access to funding, allowing them to grow lending volumes.
"Banks are significantly more comfortable with their willingness to lend to us if they believe there is a permanent takeout," said Barry Sloane, chairman, president and chief executive of Newtek Business Services, a nonbank financial firm that lends to small businesses. "For example, if there is securitization for the loans that can be funded with equity in our warehouse lines of credit, banks are more generous."
A monthly analysis of 1,000 loan applications by small businesses on Biz2Credit.com found that approvals by banks with at least $10 billion of assets totaled 11.1%, up from 10.6% in May 2012. June's approval rate was also up significantly from 8.9% in June 2011.
The index showed that the alternate lending approval rate such as that from nonbank financials was at 62.9%, posting a small decrease from a peak of 63.2% in May 2012.
Newtek is one of two issuers in the past nine months that completed a securitization of small-business loans. Bothdeals securitized the unguaranteed portion of the U.S. SBA's 7(a) loans.
The SBA does not lend money directly to small-business owners. Instead, a small-business borrower applies for an SBA-backed loan at a local bank, credit union, Certified Development Co. (CDC) or other specialized lender. The lender then provides the actual loan to the borrower.
Under its 7(a) program, the SBA guarantees a portion of the loan ranging from 50%-85%, depending on the program, limiting the lender's risk and exposure. This helps lenders become comfortable making loans that they might otherwise not approve. The program offers government guarantees of up to $5 million on loans made by commercial lenders to borrowers that face challenges obtaining financing.
The Deals
Newtek completed the securitization and sale of $20.5 million of the unguaranteed portion of the 7(a) program loans in January.
The deal added on to the $23 million deal Newtek closed in December 2010 to the securitization of $23 million in SBA loans that closed in December 2010.
That deal was followed by another completed in June 2012 by a newcomer to the space: Hana Financial, a nonbank direct lender that in addition to SBA loans, specializes in factoring, inventory financing, trade finance, equipment leasing, home mortgages and commercial real estate loans. Hana securitizated and sold $26.6 million of the non-guaranteed portions of SBA small-business loans.
Guggenheim Securities managed both deals.
John Wade, a Financial Analyst with the Office of Capital Access at the SBA, said that roughly $10.3 billion of loans have been approved in the SBA flagship 7(a) loan guarantee program in the last nine months. Additionally, lending volumes for the fiscal year 2012 in 7(a) are on track to come in somewhere around the ball park of $14 billion, he said.
"Our program is such that as you approach the end of the fiscal year everyone seems to throw everything, including the kitchen sink, in for approval," he said.
Of that volume, Wade said that the SBA has seen sales in the secondary market of the guarantee piece tracking at about $2 billion to $2.2 billion, which means that roughly a fifth and up to a quarter of the loans that are approved and disbursed have made their way into the secondary market where the guaranteed piece is sold.
"The guaranteed portions of SBA 7(a) loans are being sold in the secondary market and that market is very buoyant and the premiums are running very high," said Martin Teckler, who provides counsel for Bingham McCutchen in the SBA programs and other federal agencies that provide capital to small businesses. "The nonbanks and banks are availing themselves of the secondary market for the guaranteed portion and doing well with it."
The trend for the unguaranteed portion has been toward these smaller-sized deals. Hana's deal securitized 247 loans while the Newtek deal securitized 400 loans. Still, Wade believes that these deals are still considered good-sized securitizations.
Since nonbanks don't have a source of deposits, they also look at securitization of the unguaranteed portions as an opportunity to finance themselves more readily. "The use of securitization as a takeout for these businesses isn't new, but the market for securitization by the participants in the SBA 7(a) program was kind of dormant until the recent transactions took place," Teckler said.
The last deal to takeout a sizeable portion of unguaranteed SBA 7(a) loans was a $304 million deal that CIT completed in 2007. Today, however, none of the lender participants in the SBA loan program have expressed an interest in doing a securitization deal of that magnitude, Wade said.
These bigger commercial banks have historically been a catalyst for the larger -scale deals, and they don't get excited unless the volumes are significant. The biggest impediment to doing future securitizations from a financial institution perspective is that there is no more sale treatment at this point and that it is just financing, Sloane said. That situation takes most of the depositories out of the market to do securitization, and they were the biggest participants.
"It's not that they aren't going to make loans; it's that they aren't looking to securitize them and instead will opt to put them on their portfolio," Sloane said. "For entities like us that are nonbank lenders, securitization is the be all and end all. It puts us on an even playing field with the depository institutions if we are able to secure the long-term financing."
Sloane anticipates that securitization will help Newtek grow its originations to $125 million of financings this year from $100 million in 2011. "We anticipate $200 million worth of loans to small businesses in 2013, and we anticipate increasing our line of credit, and securitization is part of that," he said.
James Kim, senior vicepresident of small-business lending at Hana Financial, said that securitization is a tool that the company plans to increasingly use.
He explained that for each SBA 7(a) loan made, Hana must pay 25% of that loan on its books. "Our annual volume growth equates to about $100 million, and for every $100 million, we must hold $25 million of the volume we generate on our books - our capital gets tied up onto the 25% portion that is unguaranteed," he said. "With securitization we are able to securitize this 25% of the unguaranteed portion and thereby receive the necessary liquidity to make additional loans."
Hana worked on its June deal for nearly a year, and Kim said that much of the holdup on the deal was getting it rated. The company eventually received an 'A' rating from Standard & Poor's but prior to S&P the company first engaged DBRS and then with Moody's Investors Service, which were not able to rate the deal because of insufficient data on the sector.
DBRS, for instance, has rated deals with a component of small-business leases and factoring transactions, but the rating agency said that analyzing the SBA strips required data and a better understanding of how the product works to develop the criteria to help define the credit levels required.
These companies are also relatively small, which means that the operational risks in a securitization will be perceived to be higher; therefore, either some additional mitigation will be necessary or the rating agency may just not be able to get to the rating level they sought.
"The unfortunate situation was that initially they didn't want to work with us," he said. "There were two main reasons. One is that we were a first-time issuer. The other is that both companies were unfamiliar with the SBA 7(a) product. Fortunately, S&P has some enhanced data, and they were willing to work with us."
To be sure, in a spring 2012 special report on the sector, analysts at S&P said that tracking the peaks and valleys of U.S. small-business performance is difficult because of the lack of available data. The rating agency said in the report that it has been reviewing small-business data since the early 2000s. The data, extracted from the SBA 7(a) program databases, offers insight into which sectors might be headed for trouble, and that information is integrated into the S&P analytical model that shows the gross default and prepayment risk in small-business loan portfolios.
There are also the regulatory requirements around the SBA securitization of the unguaranteed portion that have to be satisfied, which Teckler said has put off some lenders from amassing the critical mass that makes doing a securitization cost effective. "These are the unguaranteed portions of the SBA loans that are being securitized, so you need to have the critical mass in order to cover the costs and make it worthwhile - and of course you have a general lull in the securitization market that has been overcome somewhat, but there is still some reticence in the marketplace over the costs of getting a deal done."
Achieving the critical mass necessary to get even a deal the size of Hana's $35 million transaction can be a challenge when the 15% unguaranteed portion is on loans with a balance between $250,000 and $750,000. "The point about critical mass is a poignant one because it takes a long time for a lot of these loans to accumulate the size sufficient for securitizations," said one ratings analyst. "So even a $25 million securitization is going to take maybe 500 loans, and most SBA lenders are originating only a few hundred or a couple of hundred a year. It's important to have that critical mass for diversification; you don't want to have concentrated pools where you are exposed to the risk of loss to a small business."
Outside of nonbank financials, commercial banks - even the smaller ones - don't really need to line up to sell the unguaranteed portion of the loan. On the one hand, many of the benefits of securitization have been done away with accounting regulations that require banks to keep deals on the balance sheet and treat these structures as a financing versus a sale.
Wade said that for banks, the securitization vehicle creates unwanted liquidity. He also underscores the fact that there is no liquidity problem at the lender level. "Lenders are stuck with a lot of inventory in the form of cash that they are trying to deploy, and the last thing they want to see is that cash coming back to them in a monetization - whether it be through a secondary market sale or securitization - and then they have to redeploy again and the transaction costs associated with that might impact their decision," he said.
The low interest rate environment has created a situation where SBA lending institutions find that they are flush with cash, and as long as this condition remains this way they will look to deploy capital with the understanding that they really don't want it back right away, Wade said. "Securitization exists to increase the velocity of money back into the lending channel," he said. "I think people will start doing this [more] as we see a rise in level of interest rate, but it isn't coming any time soon."
504 Loans
Another potential catalyst for securitization from the SBA's small-business lending programs, is the temporary 504 Refinancing Program, which was established to allow small-business owners to refinance up to 90% of the appraised value of available collateral.
The temporary program, established in October 2011 as a Small Business Jobs Act and American Recovery Reinvestment Act initiative, is authorized to provide $7.5 billion. It will be available until Sept. 27. Borrowers can finance up to 90% of the appraised value of available collateral, which could include fixed assets acceptable to SBA (for example: commercial or residential real property). This allows borrowers with more than 10% equity to be able to obtain additional proceeds to pay for eligible business expenses.
In April, SBA expanded the program parameters by allowing any business with a commercial mortgage that is two or more years old to refinance its debt, regardless of maturity. The program was put together to create liquidity in the first mortgage loans that are tied to SBA's long-term 504 loan program.
There is much interest in averting a situation where the September deadline for the program's authorization is reached and the SBA no longer has the ability to guarantee the first mortgages. Hana 's Kim said that some of the lenders under the SBA 504 temporary program are testing underwriters and investment banks to create a securitization market for these specific assets.
Teckler also commented on the activity underway to come up with a mechanism for a private label securitization of first mortgage loans generated through the SBA 504 temporary program, on general programmatic basis. He said that the potential issuers would be the same parties involved in making the first mortgage loans in the 504 program. "There are some investment banks and other sources of funding that are working on setting up a mechanism to take the place of the SBA guarantee to let them avail themselves of this securitization opportunity for these first mortgages," he said. "There is a potential of $6 billion of first mortgages that will happen in the fiscal year 2013 that would potentially be available for the securitization program next year."
According to Wade, although most of the principals that the SBA deals with are working in earnest to preserve the program instead of looking to securitize these first mortgage loans; the model formed under the government program could easily be replicated when developing a securitization interest that functions somewhat like the mechanics in the first mortgage loan pool program. "Obviously the big difference would be that there wouldn't be a government guarantee tied to the securitization," he said.
