Even with some powerful forces behind it, securitization of business loans appears to have come up against its greatest opponent: a borrower's market.

With liquidity and competition for quality middle-market and small business loans running strong, most banks are inclined to hold loans in portfolio rather than sell them into a secondary market for commercial and industrial loans.

"The economic factor that is against us now is that banks and financial institutions in general are asset hungry," said Richard C. Westergaard, a senior vice president at Norwest Corp.

The Minneapolis-based regional is among a select group of companies experimenting with programs that could foreshadow the creation of a national market for the multibillion-dollar business loan market.

Mr. Westergaard oversees the bank's Norwest Loan Partners program, which seeks to pool excess loan concentrations from banks in exchange for allowing participating banks to buy a pro rata interest in the pool.

Such efforts come on the heels of the credit crunch in the late 1980s. Bad real estate loans created the need for a liquid market for bank loans to allow banks to diversify their loan portfolios.

In an attempt to make funds available for companies, particularly to small businesses, Rep. John LaFalce, D-N.Y., pushed legislation to create a government-sponsored secondary market, called the Venture Enhancement and Loan Development Administration for Small Undercapitalized Enterprises, or Velda Sue. This agency, similar to Fannie Mae in the mortgage market, would buy, securitize, and resell business loans to investors.

That proposal never got off the ground, however. Just as the effort got under way, the economy improved, cutting into the legislation's support. There is no movement within the current Congress to revive Velda Sue.

Nonetheless, the government did pass legislation that made selling small business loans more attractive. In September, President Clinton signed Title II of the Community Development Financial Institutions Act, known as the Small Business Loan Securitization and Secondary Market Enhancement Act.

That act makes selling business loans into the secondary market more attractive to banks in a number of ways. First, it eases requirements that previously forced banks to maintain regulatory capital against the full amount of the loans sold. Now they need only to reserve against the retained portion of the loan pool.

The law also preempted state securities laws and allowed small business loan securities to come under the Securities Exchange Act, making them eligible for purchase on margin.

While these changes will likely help when a market develops, it is credit quality issues that will ultimately drive the development of a secondary market for commercial and industrial loans.

"If it affects the credit rating of the loan portfolio, then a bank will begin to look at loan concentrations by company and by industry," said Norwest's Mr. Westergaard. "Then they will look to selling some of the excess concentrations into pools."

This is what Norwest Loan Partners was created to do. In effect, participating banks can substitute one loan for an investment in a pool of loans, allowing them to diversify their loan portfolio.

But the program has faced the same factors that have slowed the development of a nationwide secondary market for commercial and industrial loans. So far, the company has completed only three transactions. But that is expected to change over the next couple of years.

"We think more and more banks will realize that it will not do them any long-term good to hold excessive loan concentrations," Mr. Westergaard said. "We expect the volume to increase significantly in 1995."

Credit quality and loan concentrations are equally important in the public market for pools of unguaranteed SBA loans. In particular, the pool should not have specific loan, geographic, or industry concentrations.

"An investor wants to know the pool is diversified. They don't want 100% of the loans in a pool from one county in the U.S.," said Len Blum, managing director and head of asset-backed securities group for Prudential Securities in New York.

Over the past two years, Prudential has securitized three pools of unguaranteed SBA loans for Union, N.J.-based The Money Store Investment Corp. The company's latest unguaranteed loan offering, completed in September, netted $129.9 million.

In every case, the loan pools were enhanced either by pledging excess servicing income earned from the guaranteed portion of the same SBA loans, or by subordinating a portion of the offering.

"The credit enhancement is driven by the rating agencies' analysis of the composition of the pool," said Michael Benoff, a senior vice president with The Money Store.

While credit considerations rule securitizations of middle-market and small business loans, the leasing industry faces a completely different set of dynamics.

In a typical lease, the leasing company gauges its monthly lease payments by a number of factors, including the residual value of the leased asset. Assets like computer equipment may have a stated three-year life. In reality, the rapid pace of upgrades in computer equipment may limit the utility of the asset to two years.

To eliminate much of this risk, the industry is looking to securitization.

"Prior to securitization, people had to wait for the expiration of the lease before they could realize cash from the property," said Steve Fier, director of federal government relations with the Equipment Leasing Association. "You get it up-front when you securitize."

The same motivation for freeing up capital is the force behind a securitization attempt sponsored by the National Association of Government Guaranteed Lenders. That effort is to put together an $80 million, multilender, pool of unguaranteed SBA loans. The loans would be similar to those pooled by The Money Store in its most recent offering.

Interest in this program is expected to come from the same types of lenders that currently use the secondary market to sell the SBA-guaranteed portion of the portfolios, in particular, small banks and nonbank lenders. Small banks like the idea because capital constraints prevent them from serving their local markets. Nonbanks like the idea because of their inability to fund the balance sheet with cheap deposits.

But Tony Wilkinson, president and chief executive of NAGGL, believes NAGGL's multilender offering will carry advantages not present in either the thriving $2 billion secondary market for SBA-guaranteed loans.

Because the loans NAGGL is looking to securitize were originally part of an SBA package, they carry standard loan documentation for ease of analysis. The lenders that originated the loans being pooled are required to provide a detailed history of loan losses on their SBA loans. The loans will likely be priced at par, instead of the premiums paid in the guaranteed market of as much as 10%.

The need for credit enhancement is one thing Prudential and NAGGL are working on for the pool. But Mr. Wilkinson hopes that requirement will fade over time.

"As we get more money into this market, we will develop a track record and become less reliant upon the SBA guarantee," Mr.Wilkinson said.

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