124. SBA secondary markets

The primary reason that SBA loans are so profitable to banks is that the SBA has created an infrastructure whereby the portions of 7(a) loans guaranteed by the agency can be transformed into AAA rated government bonds. The entity created for this purpose is known as "Colson Securities Corp." An illustration of this is as follows: 1. A bank makes a 1 million dollar loan for a person to buy a franchised gas station using the 7(a) program 2. The interest rate charged is the prime rate + 2.75% 3.

The SBA guarantees 75% of the loan (in this case 750 thousand), so that if the borrower doesn't repay and even if the property can't be sold for anything, the lender would get back 75% of their funds 4. The lender can sell the guaranteed part of the loan as bonds using several intermediary companies and Colson Securities. Since the interest rate for risk free bonds can be as much as 5 percent less then the loan interest rate, the bank can effectively keep the difference by selling the loan for 825 thousand, and is also able to skim about 0.25 to 1 percent of the annual interest payments on this portion, so that the bond buyers essentially get paid the same interest rates as other risk free bonds.

Thus the bank keeps 75 thousand and earns some residual interest. 5. The bank is left with 250 thousand at risk. If the borrower fails, the bank keeps 25% on a pro-rata basis of what the bank can collect from selling the property. Thus the annual ongoing interest earned on its 250 thousand is about prime + 4% (because of the skim) and the bank keeps the upfront gain on the sale of the guaranteed portion, representing an earning of almost 30% on the 250 thousand at risk.

In addition, the bank can sell this portion of the loan to banks such as Bank of the West and Zion's Bank so as to have no money at risk. After these developments, banks created operations for the first mortgage portions of SBA 504 loans to be bought and sold as bonds. While these bonds have no guarantee they are only likely to lose much money only if the value of the properties used as collateral declines more than 50 percent.