After years of taking advantage of the secondary market for SBA loans, Bank of Commerce in San Diego has started to reap the rewards of holding them for the interest income.

The bank, which is the seventh-largest lender under the Small Business Administration's 7(a) loan program, stands to bolster future earnings as a result of this decision.

Interest income on a portfolio of these loans can earn risk-free yields of as much as prime plus 2.75%. And because interest on SBA loans is linked to the prime rate, rising interest rates last year added 300 basis points to the yield on these loans.

However, earnings in the periods immediately following the origination of these loans suffer because the company gives up fee income from the premiums, which can reach 15% of par value on the sale of 25-year loans. The bank also gives up fees for originating new loans with the cash generated from the sale.

Peter Davis, president and chief executive of the $218 million-asset bank, admitted this was the case in 1994, when it decided to sell a maximum of $32 million of the SBA loans it planned to originate during the year. But the strategy, combined with the purchase of the San Diego operations of First Commercial Bank of Sacramento, appeared to help the bank post a 15% rise in first-quarter earnings, to $446,000, or 29 cents a share.

"The bank has changed from a short-term perspective to a long-term one," Mr. Davis said. "Our board was willing to forgo immediate profits to get even bigger profits down the road."

But changes in the secondary market for SBA loans suggest the advantage may swing around to selling. Since Fed Chairman Alan Greenspan's public comments that rates had likely peaked, demand for securitized SBA pools has soared.

"We don't have much left in inventory," said Dale Begenzer, a senior vice president with Vining-Sparks IBG, one of the largest assemblers of SBA loan pools in the nation. "I've been in this business since 1983, and I've never seen SBAs gobbled up like this."

He said prices on working-capital loans - with a seven-year maturity and coupon of prime plus 1.75% - have gone as high as 106% of par value. For loans with 10-year maturities, the premium is 8.5% over par.

But Mr. Davis said the change at Bank of Commerce is permanent, now that it has improved its capital position. He estimates the strategy will add $25,000 per month to the company's bottom line.

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