Legislative gridlock over a new budget and a narrow interpretation of a clause in the CARES Act have shut down the secondary market for Small Business Administration loans.
Funding that allows the Small Business Administration's 7(a) loans to be assembled into pools, much like mortgage-backed securities, ran out on Monday, putting a halt to a financial instrument that helps lenders sell the guaranteed portions of the loans. The SBA, which had sought $13 billion in funding authority in the 2021 fiscal year for the pooling program, had been administering the effort under a continuing resolution.
“Pooling has been suspended,” said Matthew Monaco, president and CEO at Hanover Securities, a Memphis, Tenn., company approved to arrange the 7(a) pools. “That does cause a problem, obviously.”
“The shutdown has disrupted the normal operations of the secondary market program,” said Tony Wilkinson, president and CEO of the National Association of Government Guaranteed Lenders.
The development “has the potential harm of affecting many lenders — especially small community banks — who rely on the secondary market for liquidity to help more small business borrowers," Wilkinson added.
Congress has permitted the bundling of the SBA-backed portions of 7(a) loans since 1984. The pools are attractive to investors because the principal and interest payments are guaranteed. They also provide lenders with fee income and free up the capacity to make more loans.
Pooling accounts for as much as 90% of 7(a) secondary-market activity, industry experts said.
While the seconday loan pools are on hold until a new budget is approved or another continuing resolution is passed, the SBA's flagship lending programs have been unaffected.
“In the short term, this problem will go away this next week if Congress passes an omnibus appropriation bill for” fiscal-year 2021, said Susan Turkell, a spokeswoman for Signature Bank in New York. The $64 billion-asset Signature is also one of a dozen companies authorized to arrange loan pools.
The secondary market for 7(a) loans had become increasingly popular in recent months.
Monaco said $2.1 billion in pools were created between Oct. 1 and Nov. 30, equal to roughly 43% of the volume handled in the prior nine months.
The SBA has not released data for the 2020 fiscal year, which ended on Sept. 30, and repeated efforts to discuss the situation with the agency were unsuccessful.
The surge in volume reflects the view that guaranteed loans are a safer bet for investors in uncertain times, industry observers said. Also, lenders are looking to clear a backlog that built up during the spring and summer when most of their attention was devoted to the Paycheck Protection Program.
Banks “got behind on the 7(a) side,” Monaco said. “Lenders out there are hungry to make these loans and there’s still a very strong demand from investors. … They love the product. The fact is that you’ve got a variable-rate product that’s outyielding Treasurys.”
The SBA could resolve the issue, industry observers argue. They point to a clause in the coronavirus stimulus package that allocated $100 billion of funding authority through Sept. 30, 2021, for guarantees of trust certificates authorized by section 5(g) of the Small Business Act.
Agency officials have interpreted the provision as applying only to PPP loan sales.
“That language [in the provision] is quite clear, in our opinion,” said Wilkinson, who asserted that the shutdown is “unnecessary” and criticized the SBA’s interpretation of the law.
The 7(a) program offers guarantees of up to 90% on loans to small businesses. Lenders approved $22.6 billion in 7(a) loans in the 2020 fiscal year.
