Comment: Get an Edge by SecuritizingSmall-Business Credits

Securitization has taken place for many years with all kinds of assets, including car loans, credit cards, and mortgages. The simple process of securitization-turning individual loans into securities-is familiar to bankers.

But few are securitizing loans to small businesses.

With changes in the regulatory environment, the opportunity to turn these loans into securities is now not only feasible, it is a reality. Innovative bankers who seek a competitive edge are finding the securitization process also gives them a strategic advantage.

No longer are standardized underwriting, lack of sufficient information on loan portfolios, and the heterogeneity of commercial loans perceived as barriers for the securitization of small-business loans.

Bankers who take advantage of securitization will find that it enhances their financial flexibility and supports asset-liability management.

Securitization of small-business loans can:

Minimize a bank's reliance on deposits and capital to fund loan growth.

Increase the bank's lending capacity by leveraging the balance sheet.

Increase liquidity in the bank's balance sheet.

Provide new revenue sources through fee income and servicing income.

Substantially improve the bank's return on assets in its small-business loan portfolio.

Small-business loan securitization will proceed on four fronts.

For government-backed loans, Congress recently directed the Small Business Administration to publish rules under which both depositories and nonbank lenders can securitize the unguaranteed portion of section 7(a) loans.

Banks and nonbank lenders have utilized a secondary market for the guaranteed portion of the SBA's 7(a) loans for years, but historically only a few large nonbank lenders have been able to securitize the unguaranteed portion of these loans.

Many banks have sizable portfolios of SBA loans on their balance sheets, and these loans have characteristics that are conducive to securitization, such as similar underwriting standards and documentation.

The ability to securitize both the guaranteed and unguaranteed portions of 7(a) loans makes SBA lending even more attractive to lenders.

The second type comprises the first deed of trust loans made under the SBA's 504 loan program. These assets can be easily securitized, because they have conservative underwriting standards, a strong collateral position with a 50% loan-to-value ratio on owner-occupied commercial real estate, and long-term repayment structures.

Credit-scored small-business term loans between $50,000 and $250,000 can also be securitized. The credit-scoring aspect of this asset type is important because it allows the securities underwriters to more accurately gauge the credit standards of different lenders in a pool. Credit scoring, in addition, provides significant efficiencies and cost savings for the originating bank.

The fourth type of loans consists of commercial real estate term loans between $200,000 and $2 million. Banks have been reluctant to emphasize this type of lending because of the interest rate risk and credit exposure. With the sale and securitization of these loans, this exposure is transferred from the originating lender to the capital markets.

Competitive pressures and technological advances have driven larger banks and nonbank lenders to small-business lending, which was once the mainstay of community banking.

Informed observers are convinced that the community banking franchise is under siege. According to most predictions, today's 10,000 commercial banks will consolidate into 6,000 to 8,000 banks over the next five years.

For the past two years, there has been more than one bank merger each business day, and this level of activity has not waned in 1997. Since there are fewer than 300 banks with assets over $1 billion, the lion's share of consolidation is occurring at the community bank level.

Competition for the community bank customer has escalated on both the asset and liability sides of the balance sheet; this pressure comes from larger commercial bank competitors as well as nonbank providers of credit, deposit, and investment services.

On the asset side Money Store, American Express, GE Capital, and a host of other lenders are vying to meet the credit needs of small businesses and consumers, whether those borrowers are affluent or low-income and whether their credit histories are impeccable or impaired.

These nonbank lenders and large commercial banks are utilizing credit scoring to underwrite loans, and are making great strides in small-business lending. The efficiencies and cost savings of credit scoring allow large institutions to lend to small businesses across the nation; thus, community banking's enviable market share of small-business banking is at risk.

How can community banks effectively compete? They must sell and securitize small-business loans on the secondary market.

Asset securitization will provide community banks with the financial flexibility to compete effectively against competitors of all types, while retaining their strong relationships with their customers.

Community banks are enjoying the benefits of a strong economy that is producing robust loan demand from creditworthy small businesses. At the same time, the disintermediation of banks' deposit base is causing the industry to lose billions of dollars to mutual funds and other investments. These events are making it increasingly difficult for community banks, which rely heavily on deposits to fund loans, to meet the credit needs of their customers.

Loan sales and securitization can provide community banks with the enhanced financial and operational flexibility that will be necessary to meet the expectations of their small-business customers. They will be able to meet the competitive pressures from other banks and nondepository lenders and remain strong, independent, and responsive.

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