Small Business Administration

This report discusses the secondary markets for small business loans guaranteed by the Small Business Administration (SBA). The secondary markets allow lenders to sell 7(a) loans they originate and to obtain funds for further lending. In most transactions, the 7(a) loans are pooled and sold to investors as tradable financial claims on the cash flows that the pools generate. GAO (1) discusses the benefits and risks of secondary loan markets to participants; (2) identifies primary benefits and risks to participants in the guaranteed 7(a) secondary market and the unguaranteed 7(a) secondary market; and (3) compares the guaranteed 7(a) secondary markets with the secondary market for federally guaranteed residential mortgages and the unguaranteed 7(a) secondary market with the secondary market for residential mortgages without a federal guarantee.

GAO noted that: (1) the proportion of loans that are sold in a secondary market depends on the benefits generated by the secondary market and how the benefits and risks are distributed among market participants; (2) by linking borrowers and lenders to national capital markets, secondary markets benefit lenders, borrowers, and investors; (3) these markets: (a) tap additional sources of funds; (b) reduce dependence on availability of local funds; (c) help to lower interest rates paid by borrowers; and (d) help lenders manage risks; (4) they provide lenders a funding alternative to deposits and, by enhancing market liquidity, they can reduce regional imbalances in loanable funds; (5) secondary loan markets can benefit borrowers by increasing the overall availability of credit in the primary market and by lowering the interest rates borrowers pay on loans; (6) the secondary markets in 7(a) loans provide lenders a funding source that otherwise would not be available; (7) in calendar year 1997, 1,540 SBA lenders sold 12,164 SBA 7(a) loans in the guaranteed secondary market, generating $2.7 billion in sales of guaranteed portions; (8) about $290 million in sales of unguaranteed portions were made that year by a smaller number of lenders; (9) these were generally Small Business Lending Companies, which lack a deposit base, or banks that had not developed a sufficient deposit base as a funding source for their loans; (10) lenders participating in these markets can reduce funding costs, and investors in 7(a) pool certificates and securities can get greater liquidity and lower risk than they would from directly investing in individual loans; (11) in the guaranteed 7(a) market, investors face prepayment risk, and in the unguaranteed 7(a) secondary market, investors and lenders share prepayment and credit risk; (12) both 7(a) secondary markets can help lenders make more loans, which could contribute to a concentration of SBA's credit risk among a few lenders that originate a large percentage of 7(a) loans; (13) compared to the secondary markets for 7(a) loans, the secondary markets for residential mortgages operate with greater incentives for lenders to sell the loans they originate; (14) in 1997, about 45 percent of the guaranteed portions of 7(a) loans originated that year were pooled and sold on the secondary market compared to virtually all federally insured single-family residential mortgages; and (15) about 11 percent of the unguaranteed portions of 7(a) loans originated in 1997 were pooled and sold on the secondary market compared to about 32 percent of nonconforming residential mortgages.