As industry participants debate rules designed to restart securitization of private-label mortgages, another corner of this market is showing signs of life: the nonguaranteed portion of loans backed by the Small Business Administration (SBA).
Newtek Small Business Finance, a non-bank lender that is licensed as a small business lending company, securitized $23 million of the nonguaranteed portion of SBA Section 7(a) term loans, which are typically secured by commercial or owner-occupied residential real estate.
While a $23 million deal might not seem like much of a milestone, Newtek Small Business Loan Trust 2010-1 was the first securitization of any kind of nonguaranteed small business loan since 2008, and it may have been the first securitization of the nonguaranteed portion of 7(a) loans since 2006. The $16 million of floating-rate notes issued off of the collateral were rated double-A by Standard & Poor's and priced at 5¾.
Guggenheim Securities advised Newtek on the deal.
Barry Sloane, chairman of Newtek Business Services, the SBLC's parent company, said the deal's small size and the lack of a secondary market for these securities were no impediment to getting it done. "There's tremendous demand — different investors need to put $16 million away at double-A spreads," he said.
While the collateral is uninsured, it is not subordinated, in terms of repayment. Instead it ranks pari passu with the government-guaranteed portion of these loans.
Unlike Fannie Mae, Freddie Mac and the Federal Housing Administration, which guarantee 100% of the principal and interest of mortgages that meet their criteria, the SBA only guarantees 75% of loans made through the Section 7(a) program. (The limit was temporarily raised, to 90%, as part of the economic stimulus act, but the SBA ran out of money to fund the break in May 2010.)
The secondary market for the guaranteed portion of 7(a) loans dates back to 1975; these securities command a premium, now around 10% of face value.
(Sloane said that premium is important, because lenders can't charge borrowers fees on the loans; the only fees borrowers pay go to the SBA to offset the cost of the program. Apart from the income they earn servicing these loans, a gain on sale is the only source of profit.)
The SBA only gave the green light for securitization of the nonguaranteed portion of 7(a) loans in the mid-1990s, first to non-bank lenders, and then to all lenders. Even then, many lenders chose to keep the nonguaranteed portion of the loans on their books.
Sloane said that when credit markets seized up following the collapse of Lehman Brothers in the fall of 2008, even the guaranteed portion of 7(a) loans ran into trouble, because the broker-dealers designated by the SBA as "pool assemblers" couldn't finance their positions.
The secondary market for these securities restarted with the help of the Federal Reserve's Term Asset-Backed Loan Facility. Sloane said it has since "heated up," with premiums of 112-113, versus 105-106 at the depths of the credit crisis.
Meanwhile, securitization of the nonguaranteed portion of these loans has been held back, in part because it's so difficult for many lenders to assemble enough collateral. Even before the credit crisis, the unguaranteed portion of 7(a) loans were often combined with so-called conventional, or non-guaranteed small business loans to collateralize deals, according Weili Chen, senior director, U.S. structured credit at S&P.
(Some of the collateral for Newtek Small Business Loan Trust 2010-1 had been originated as early as 2000. At the time of securitization, the remaining weighted average term of the loans was 142 months.)
The performance of small business loans has also been poor. S&P doesn't publish delinquency data, but Chen said the rate of small business failures has been "unprecedented" compared with the past few recessions.
Also, many of the loans themselves are backed by commercial or residential real estate, so even some viable businesses are underwater on their loans and cannot readily refinance them.
S&P is reviewing its ratings criteria for the small business securitization sector.
Sloane said Newtek "worked with S&P a long time" on its deal. The credit enhancement the agency required to assign the notes a double-A rating was "almost triple" the amount on Newtek's previous deal in 2006. This "makes the deal more robust, but it also raises cost of capital," he said.
Still, even with the additional credit enhancement, Sloane said, securitization is superior to a term loan with a bank. "It's matched funding," he said.
Newtek is using proceeds from the securitization to pay off a term loan it had with Capital One Bank and to make new loans. It has also obtained a new warehouse line of credit from Capital One to finance origination of the guaranteed portion of 7(a) loans.
Newtek originated $25 million of 7(a) loans in the first quarter of 2011; Sloane expects to originate as much as $125 million of these loans this year. He hopes to do another securitization of the nonguaranteed portion of the loans later this year.
Newtek originated $65.5 million of SBA loans in the fiscal year ended Sept. 30, 2010, according to the SBA. That made it the second most active SBLC, behind CIT Small Business Lending Co., a unit of CIT Group.
Sloane said securitizing the nonguaranteed portion of the 7(a) loans it makes confers additional benefits to Newtek — which, in addition to lending to small businesses, offers electronic payment processing, payroll services, data backup, storage and retrieval, Web hosting, and insurance services. "It's important to our position as an authority on small business to be an authority on finance to the small business market."
Sloane said the small business lending market, which he defines as loans of $50,000 to $10 million, is "huge," representing 20 million businesses.
With a customer base that will personally guarantee loans and has sufficient collateral and cash flow, 7(a) lending offers "a great risk-reward lending environment" compared with other markets, he said.
"This is going to be a significant market — it's one of the last to be securitized," Sloane said.