Congress on the Move: The Securitization of Small Business Loans and Other Aspects of the New Banking Legislation
Miller, Dianne, Journal of Commercial Lending
In August, Congress passed HR 3474, the Riegle Community Development, Credit Enhancement and Regulatory Improvement Act of 1994, an omnibus banking bill wit provisions that run the gamut from community development lending to consumer protection to reduction of regulatory burden to reform of the flood insurance program. HR 3474 also aims to increase lending to small businesses by facilitating the development of a secondary market for small business loans. Th bill has been presented to President Bill Clinton, and he has indicated that he will sign it.
A secondary market for small business loans is not a new idea in Congress--support has been building over the past several years, fueled by the success of mortgage-backed securities and evidence of a "credit crunch" that substantially reduced the amount of credit available to small businesses.(1) Several alternative secondary market proposals were introduced in Congress in 1994, including bills to create a new small business government-sponsored enterprise (GSE)(2) and to involve the Treasury Department in certifying "secondary market facilitating organizations."(3) The legislation that prevailed, however, minimized the government's participation in the small business secondary market, leaving it to develop in the private sector.
The Small Business Loan Securitization and Secondary Market Enhancement Act of 1994,(4) contained in Title II of HR 3474, is patterned after a 10-year old initiative, the Secondary Mortgage Market Enhancement Act of 1984 (SMMEA), whic led to increased private sector participation in the mortgage-backed securities market.(5) SMMEA amended the federal securities, banking, pension, and tax laws and preempted some state securities and investment laws to make it possible for banks, thrifts, and other private sector entities to issue mortgage-backed securities. In addition, the Securities and Exchange Commission (SEC) recently exempted structured or asset-backed financings from the Investment Company Act of 1940 to further encourage the development of private sector secondary market initiatives.(6)
Although some small business loans have been securitized, a number of legal regulatory, and practical barriers have prevented robust growth of the secondar market.(7) Barriers include the following:
* Bank capital and accounting rules that discourage the sale of loans with recourse.
* Securities delivery and margin requirements that inhibit the pooling process.
* The potential for double taxation.
* Lack of standardization of loans. The Small Business Loan Securitization an Secondary Market Enhancement Act, however, removes these impediments so that th secondary market may develop without forcing transactions to fit into narrow legal or regulatory categories.
Without competition from GSEs--which has somewhat restricted the growth of the private mortgage-backed securities market--the small business secondary market should develop into a profitable line of business for lenders.
Provisions of the Legislation
The Small Business Loan Securitization and Secondary Market Enhancement Act is not a structured program; rather, it is a series of changes to existing law tha will allow a secondary market for small business loans to develop. The legislation begins by creating a new small business-related security, defined a an investment-grade security (as determined by a statistical rating organizatio such as Moody's or Standard & Poor's) that represents an interest in a pool of small business loans or leases or provides for payment of principal in relation to payments, or a reasonable projection of payments, on a pool of small busines loans or leases.
For secondary market purposes, a small business is defined as a business that meets the criteria for a small business concern established by the Small Business Administration (SBA) under Section 3(a) of the Small Business Act. …