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Secondary Market Access: Your Inside Source for Selling 504 First Mortgages

Mar 2010

NOTE:The SBA expects to begin issuing the first loan pool guarantees in April of 2010.

As part of the American Recovery and Reinvestment Act, Congress authorized the Small Business Administration (SBA) to create a temporary program that provides guarantees on eligible pools of 504 first mortgages to be sold on the secondary market.

Secondary Market Access (SMA) is a consortium of certified development companies (CDCs) and financial companies, including Florida First Capital, that was created to help 504 first mortgage lenders take advantage of this new program aimed at rejuvenating an otherwise stalled secondary market.

SMA has partnered with a major U.S. investment bank to purchase 85% participating interests of individual loans in order to form eligible loan pools. SMA's role is to source transactions, package, audit and facilitate funding on behalf of the pool originator. Florida First Capital's role is to serve as facilitator and point of contact for interested first mortgage sellers in Florida.

The eligibility of each loan is dependent on the date of the SBA debenture funding. To be eligible, the debenture must have been funded on or after Feb. 17, 2009, and prior to Feb. 16, 2011.

For the purposes of the program, a pool is defined as two or more loans. A pool must be either fixed (for life) or adjustable (any period adjustment including five or 10 years). If the pool is comprised of adjustable rate loans, all loans must have the same base rate (e.g., Prime, LIBOR, LIBOR Swaps, FHLB, etc.). Finally, each loan must be current for the lesser of six months or from the time of loan funding.

Loan Pool Criteria

Each loan pool will have three participants: the Seller, the Pool Originator and the Investor.

• The Seller is the bank that either made the loan or purchased the loan from the original, or subsequent, lender. The Seller will hold 15% of each loan. The Seller will be paid a premium for the participation interest sold (equal to 85% of each loan), and will receive at least .50 basis points in servicing as mandated by the SBA. The Seller's loan interest is not guaranteed by the SBA, but can be resold at a later date subject to SBA approval and 100% divestment of the loan (including servicing). The Seller will receive a Seller Certificate at pool formation.
• The Pool Originator will purchase the 85% participation interest in individual loans in order to form eligible loan pools. The Pool Originator must hold 5% of each loan for the life of the loan. This portion will not be guaranteed by the SBA and cannot be resold. The Pool Originator will receive a Pool Originator Certificate at pool formation.
• The Investor will purchase 80% of each loan pool, which will be guaranteed by the SBA. Unlike the SBA 7(a) loan, an originating bank may not fund a loan, or pool of loans, and then apply for a guarantee as part of a portfolio strategy. The guarantee is finalized only when an unaffiliated buyer (or buyers) agrees to be an Investor in a loan pool. Two other key differences to the 7(a) program are that the prepayment penalty will flow to the investor (not the SBA), and there is no cap on the interest rate charged other than what is mandated for a normal 504 first lien. The Investor's interest can be resold. The Investor will receive an Investor Certificate at the time of pool formation.

Some lenders may elect to be both the Seller and the Pool Originator. If lenders choose this option, they must hold 20% of each loan and 5% for life.

The SBA has also required that each loan have a payment date of the first of each month, and that each loan payment be automatically deducted via ACH (as is required for the SBA debenture). Once a loan pool is executed, Colson Services will automatically draw 100% of each payment and will distribute the proceeds to the Investor, the Pool Originator, the Seller and the SBA.

Benefits to Lenders

The primary benefit for lenders will be premium income on the 85% participation interest sold to the Pool Originator. Another benefit will be long-term servicing income of at least .50 basis points paid to the Seller on the sold portion of each loan (normally 85%).

Capital continues to be a primary concern for local community banks. With the ability to sell 85% of each loan, banks will have to invest a limited amount of capital into each loan transaction. This means some banks that were unable to fund high dollar real estate loans for their small business customers will now be able to get back into the market. For banks that were limited in their fundings due to capital restraints, they will be able to leverage their funds and make four or five similar sized loans for the same capital cost as one unsold loan.

A key feature of the pool guarantee program is the originating lender will continue to be the “public face” to the small business owner/borrower. A large percentage of lenders refused to sell whole loans in the old secondary market for fear of losing contact with their customers and the appearance of being “just a broker.” In this program, the selling lender will have the only interaction with their customers and will be able to cross sell multiple business and personal banking products.

SMA is currently seeking eligible funded loans in order to build efficiently sized loan pools that result in the maximum price paid to the selling lender.

If you have loans where the debenture funded on or after February of 2009 (includes first liens funded in 2008), please contact Deborah Petrell, FFCFC Senior Vice President and Sales & Marketing Manager, at 561.756.1745 or by email atdeborah@ffcfc.com.