Small Business Administration:

Secondary Market for Guaranteed Portions of 7(a) Loans

T-GGD-98-184: Published: Sep 23, 1998. Publicly Released: Sep 23, 1998.

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Pursuant to a congressional request, GAO discussed the Small Business Administration (SBA) 7(a) guaranteed loans secondary market, focusing on the: (1) benefits generally provided by secondary loan markets; (2) characteristics of the secondary market for federal government guaranteed mortgage loans; and (3) characteristics of the guaranteed 7(a) secondary market in relation to those of the Government National Mortgage Association (Ginnie Mae) mortgage-backed securities (MBS) secondary market.

GAO noted that: (1) the 7(a) loan program, SBA's largest lending program, is intended to serve small business borrowers who cannot otherwise obtain financing under suitable terms and conditions from the private sector; (2) secondary loan markets link borrowers and lenders in local markets to national capital markets, thus reducing dependence on local funds availability; (3) the secondary market in residential mortgages is recognized for creating this link; (4) this secondary market has reduced regional imbalances in the availability of loanable funds; (5) other benefits, which include tapping additional sources of funds, have also helped to lower interest rates paid by borrowers; (6) in addition, this secondary market allows interest rate risk inherent in holding fixed-rate loans to become diversified among investors that might be better able to hedge against such risks than loan originators; (7) in contrast to Ginnie Mae guaranteed MBS that are backed by cash flows from whole loans, 7(a) loans are divided into separate guaranteed and unguaranteed portions for secondary market sales; (8) preliminary results indicate that the guaranteed 7(a) secondary market has also linked borrowers and lenders in local markets to national capital markets, and thus generated some of the benefits generally created by other secondary markets; (9) however, the guaranteed 7(a) secondary market has characteristics that limit its size in relation to the primary 7(a) market; (10) in particular, most 7(a) loans are variable-rate loans with almost no interest rate risk, which reduces incentives for some lenders to use the secondary market; (11) in addition, 7(a) secondary market investors, relative to MBS investors, have less information to accurately estimate their exposure to risks associated with borrowers paying off their loans before they are due (prepayment risks), which may limit whether or how much they are willing to participate; (12) secondary market volume for both the guaranteed portions of 7(a) loans and federally insured residential mortgage loans is a market outcome that depends on the relative benefits provided by the respective secondary markets compared to other methods of finance; and (13) for the most part, SBA has few if any means to change factors that, through market forces, limit the relative size of the secondary market.

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