The Small Business Administration is counting on two changes to its loan programs to jump-start the sputtering SBA lending market.
Thinning profit margins, brought on by wild swings in interest rates, have discouraged lenders from offering the loans and investors from buying them on the secondary market. As a result, SBA loan volume has plummeted in recent weeks.
Hoping to get both sides of the market moving again, the SBA said Thursday that lenders can price loans at 300 basis points above the London interbank offered rate, rather than at the prime rate. The switch should widen the spread between the cost of funds and the rates lenders charge, and it could make the loans more attractive to investors, whose cost of funds are pegged to Libor.
To further stimulate a secondary loan market that has all but dried up of late, the SBA is allowing pooling service firms that package SBA loans for investors to include loans with different rates in their pools. Previously, only loans with the same rates could be packaged together, and the firms have struggled to assemble pools as volume has dropped.
The industry's reaction to the changes, which took effect immediately, was mixed. Pegging the rates to Libor, rather than the prime rate, should encourage more lenders to make SBA loans, observers said, but they are generally skeptical that changing the makeup of loan pools will do much to get the secondary market moving again.
Dave Straus, the chief executive at the $69 million-asset Fortune Bank in Seattle, sees the changes as beneficial.
"I think it'll help the problem, especially if we get back to a situation where the relationship between the Libor and the prime goes back to a bigger spread again," he said. "Until the premiums return to normal, it makes SBA a hard business to be in."
But Chris Reilly, the president of CIT Group Inc.'s CIT Small Business Lending Corp., warned that these changes alone would not cause the secondary market to spring back to life. In fact, she said selling loans could become harder if lenders start making more SBA loans, because the supply would increase while the demand would remain scant.
"You're going to have a lot of supply of paper at a lower price, because it was prime-based," she said. "That's a bit of a challenge as lenders and broker-dealers move through that inventory."
More will have to happen for liquidity to return to the market, according to Ms. Reilly, whose firm applied to become a bank holding company Thursday. "In the near term, in the immediate term, if there were an agency of the government that was willing to buy that paper or accept it in advance to provide liquidity, that would be ideal," she said.
Before the start of the credit crisis, the prime rate — the only rate at which lenders were allowed to make SBA-guaranteed loans — stayed steady at about 300 basis points above Libor, the rate at which most banks borrow from one another to fund their operations. But that rate shot up as conditions worsened, making it far less profitable to lend at the prime rate.
In a news release Thursday, acting SBA administrator Sandy K. Baruah said that the mismatch between Libor and prime had been squeezing SBA lenders out of the market. The change, he said, "will help more small businesses obtain capital to grow their businesses and create new jobs. SBA is making its programs more flexible, increasing opportunities to access capital and giving both lending partners and small business customers more options."
The number of SBA loans made from Oct. 1 to Nov. 7 fell 50% from the same period last year, while the dollar volume fell 37%. The secondary market dried up, and lenders had to keep their loans on their books.
Relaxing restrictions on loan pools, the SBA said, would give investors more incentive to bid on them.
Eric Zarnikow, the SBA's associate administrator for the office of capital access, said Thursday that it was high time to allow loans with different rates to be pooled together — a common practice in other securitized loan markets. "We were a little bit behind the curve," he said.
Still, Jim Reber, the president and CEO of ICBA Securities, a unit of the Independent Community Bankers of America, said how borrowers will react to the changes remains to be seen, since most small-business owners probably have not heard of Libor and might not be comfortable with the fluctuating rates.
He also said most loan pooling companies do not deal with Libor-based loans or use the rate to borrow for themselves. The wild Libor fluctuations will not be an appealing alternative to the steadier prime rate, on which SBA loans are currently based, Mr. Reber said, and poolers would find selling Libor-based loans to investors even harder.
"Asking the middle man to sit on some loans that don't sit well into their funding source for a potentially long period of time, and waiting for investment demand to materialize out of the secondary market, is asking a lot," he said.