SECURITIZATION OF CONVENTIONAL SMALL BUSINESS LOANS
While there are a few differences, the structures for conventional small business loan transactions are similar to those of the unguaranteed portions of SBA 7(a) loans. One distinction is the excess spread available. Note, for 7(a) transactions, excess spread from the entire loan is available with only the unguaranteed portion being securitized, where for conventional business loans the entire loan is in the transaction.
Conventional small business loans are also made to “qualifying borrowers,” whereas the eligibility requirement of SBA loans is for borrowers that cannot obtain this financing. Therefore, the quality of conventional small business loans is generally better than SBA loans.
The average loan balance for conventional business loans for the most part will be higher than the SBA due to a lack of SBA limits on loan size. Also recall that SBA loans are typically floaters indexed to the prime rate. Conventional loans tend to be indexed to three-month LIBOR because the investment community prefers LIBOR floating rate bonds. Indexing the underlying collateral to the same index mitigates basis risk. SBA transactions have basis risk; however, the rating agencies take this into consideration when specifying levels of credit enhancement for deals.
Large portions of conventional loans are secured by first liens on real commercial property. Transactions will often consist of pools of loans backed almost completely by real estate collateral. When the loan is not backed by real estate, losses on defaulted loans will typically be higher due to the lack of real estate collateral, which is generally an appreciating asset, versus collateral such as equipment, which is a depreciating asset.
Prepayment penalties for conventional loans tend to be more severe than the SBA. Penalties are set by the lender and will likely start at 5% and step down one percentage point per year for the first five years following disbursements.
SBA transactions are generally more geographically diverse than conventional transactions. Forty-eight states could be represented in an SBA transaction where conventional transactions may contain only eight with around 70% of loan concentration in one state. Small business performance is negatively affected by downturns in economic cycles; the geographic diversity of SBA transactions lessens some of this risk.