ST. LOUIS - When Lew Stone bought two portfolios of U.S. Small Business Administration-backed loans from the Federal Deposit Insurance Corp. last year, he did not intend to keep them.
After cleaning them up, he planned to resell the portfolios to St. Louis-based ITT Small Business Finance Corp., which had already expressed an interest.
So far, the relationship with ITT has worked well for both parties. Mr. Stone, president of Goleta State Bank in Goleta, Calif., has already sold one servicing portfolio containing $40 million face amount of the unguaranteed portion of SBA loans, and is in discussions to sell another $25 million pool.
The reason is simple, he said.
"When we enter into a transaction with them, what they say will happen and what actually happens are exactly the same," said Mr. Stone.
Besides being one of the most active SBA lenders over the past five years, ITT has also been one of the most active buyers of SBA loan servicing portfolios. In all but one of the last five years the company has been able to pick up more of these portfolios, which include the actual loan and servicing for the unguaranteed portion of the loans, as well as the servicing for SBA-guaranteed portions. Typically, this guaranteed portion has been stripped away and sold to investors in the secondary market.
In the past two years alone, the company has bought portfolios servicing an estimated $150 million worth of SBA-backed loans.
"We've been very active," said Tony Feraro, president of ITT Small Business Finance.
With the frequent purchases, the company has developed expertise. Using a group headed by Jerry Sullivan, ITT Small Business' senior vice president in charge of operations, Mr. Feraro said the company can review up to 50 loans a day.
Despite statements from competitors to the contrary, Mr. Feraro said these pools are typically bought at a premium over face value.
"The word on the street is that we buy these portfolios at a discount, but they're just jealous," he said.
While sales of the guaranteed portion of SBA loans are common, portfolios that include servicing for both the guaranteed and unguaranteed portion rarely come up for sale. The reason is the SBA prohibits banks participating in its popular 7(a) loan program from selling the unguaranteed portion of their portfolios.
The thinking behind this prohibition is that by forcing these lenders to hold a stake in the loans, they will monitor them more carefully.
As a result, only lenders who are getting out of the SBA loan program are allowed to sell their unguaranteed portfolios.
Nonbank lenders in the program are not subject to this prohibition, however. This small, but active, group of SBA participants are free to sell both the guaranteed and unguaranteed portions for liquidity purposes. So far, only the Money Store Investment Corp. and PMC Capital of Dallas have taken advantage of this rule.
But these sales have their drawbacks, said Mr. Sullivan. He contends that these sales allow lenders to get every ounce of income out of the loan up front. If the loan goes into default, however, the lender has nothing to lose, a situation that scares Mr. Feraro.
"My concern is not the lender. My concern is what is the potential exposure to the agency three to five years down the road," he said.
With the new Congress looking for ways to cut the SBA or eliminate it altogether, he said bad loans sold in this way could backfire on the industry. And it could help to ruin what he and his employees have built from scratch.
In the 13 years since he left community banking in New Jersey and started ITT Small Business Finance, Mr. Feraro has helped build an organization with a $700 million loan-servicing portfolio and 98 employees. The company created this portfolio through acquisitions and by being one of the most prolific SBA lenders in the nation.
During the SBA's 1993 fiscal year alone, the company was the third- largest lender in the market, originating 278 loans worth a total of $107.4 million. This past year, the numbers were even higher - 289 loans worth $110.4 million - though the ranking fell to third behind the Money Store, Banco Popular de Puerto Rico, and Heller First Capital Corp.
There are no special lending tricks here. While it has looked into using credit scoring and other methods of streamlining operations, the company still uses traditional due diligence in its underwriting.
"It's a deal-by-deal business," said Mr. Sullivan. "Until you go out and see what that company is doing at its home base, you don't have a clear idea of what they're doing."
Likewise, the company's marketing efforts are primarily hands on. Mr. Feraro points out his group wears out a lot of shoe leather pounding the pavement in an attempt to drum up new business.
Much of this effort is targeted at business owners, accountants, small business counselors, and even bankers who work closely with these companies.
So far, most of that leather is being left in the Northeast, the Midwest - particularly in Illinois and Missouri - Florida, Georgia, and Texas, where the company's portfolio is concentrated.
ITT Small Business Finance has also opened a new office in Charleston, S.C., and Mr. Feraro is considering expanding into Alaska and Canada.
The company's parent, $11.7 billion-asset ITT Financial Corp., has been very accommodating to its small business subsidiary, Mr. Feraro said.
