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The SBA Market – An Overview. Third Quarter 2013. The SBA Pool Market How It Was Established. Prior to 1984 the SBA secondary market was limited to the trading of individually guaranteed loans .
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The SBA Market – An Overview Third Quarter 2013
The SBA Pool MarketHow It Was Established • Prior to 1984 the SBA secondary market was limited to the trading of individually guaranteed loans. • The U.S. Small Business Administration Secondary Improvements Act of 1984 authorized, among other things, the means by which SBA pool assemblers could create and market guaranteed loan pools similar to commonly used mortgage-backed securities.
The SBA Pool MarketApproved Assembler • Coastal is an SBA approved pool assembler • Among the most active in the secondary market • To become an approved assembler, Coastal was required to demonstrate its financial stability and good standing with the SBA
The SBA Pool MarketSBA Pool Requirements • No fewer than 4 individual loans per pool. • No individual loan in the pool may exceed 25% of the total pool. • Minimum pool size of $1,000,000. • The maturity of the shortest individual loan in any pool must be no less than 80% of the maturity of the longest individual loan in the pool or 76% for weighted average coupon (WAC) pools. • Minimum pool certificate denomination (minimum investment) of $25,000. • Pool certificate multiples in excess of minimum certificate denomination of $5,000. • Maximum difference between the highest and lowest individual loan coupon in any standard pool is 2%.
The SBA Pool Market What are the differences between SBA Pools and Mortgage Backed Securities?
The SBA 7(a) Pool Market Differences Between SBA Pools & MBS • Principal payments to investors are done on an amortization schedule based upon the maturity date of the pool. • This is determined by the maturity date of the longest individual loan in the pool. • For example, if a pool contained four loans: Three with maturities of 7 years One with a maturity of 5 years • If all three 7 year loans prepaid, the 5 year loan would still amortize based on a 7 year schedule until it matured in 5 years at which time the remainder of the pool would payoff in one balloon payment.
The SBA 7(a) Pool Market Differences Between SBA Pools & MBS • A guaranteed fund is held by the SBA to ensure timely principal and interest payments. • Realized prepayments on MBS pools have traditionally been influenced by rate directionality while SBA pool prepayments are influenced more by yield curve shape.
The SBA 7(a) Pool Market Differences Between SBA Pools & MBS • Most MBS ARMs have caps - both periodic and lifetime. During times of rapid rate increases a MBS ARM pool may not be fully indexed • - This affects market value and yield to investor. • There are no periodic caps on SBA pools • - Most pools do not have life caps. There are a few capped pools in the marketplace.
The SBA 7(a) Pool Market SBA Pool Structure • SBA Variable Rate Structure • 84 day delay • Several indices are available, but U.S. Prime rate has been all but exclusive – used in almost 99% of all production • Some are spread above the index and some below • Adjust either monthly or quarterly • SBA Fixed Rate Structure • 70 day delay
The SBA 7(a) Pool Market What are the similarities between SBA Pools and Mortgage Backed Securities?
The SBA 7(a) Pool Market Similarities Between SBA Pools & MBS • Some of the similarities include: • Monthly principal and interest payments. • Loans underlying SBA pools may be prepaid by borrower without penalty (except for the first 3 years on new loans with maturities of 15 years or longer). • Like GNMA securities, SBA pools are fully guaranteed as to the timely payment of principal and accrued interest by the full faith and credit of the US Government. • FNMA & FHLMC securities do not carry this same guarantee.
The SBA 7(a) Pool Market Similarities Between SBA Pools & MBS • Both mortgage-backed securities and SBA pools pay interest in arrears and all yield calculations factor in the "delay days". • Both GNMA securities and SBA pools have been placed in the zero percent category under risk-based capital guidelines.
The SBA 7(a) Pool Market Similarities Between SBA Pools & MBS • Both government or agency guaranteed home mortgages which provide the underlying collateral for mortgage-backed securities (MBS) and SBA pools will statistically suffer some rate of mortality due to default or prepayment of individual loans within a pool prior to their stated maturities.
The SBA 7(a) Pool Market What is Constant Prepayment Rate (CPR)?
The SBA 7(a) Pool Market Constant Prepayment Rate • Rate at which loans prepay over normal amortization • As loans pay off, principal is returned to the investor • The appropriate amount of premium must be amortized - the faster premium is amortized, or written off, the lower the investment yield during the amortization period.
The SBA 7(a) Pool Market Constant Prepayment Rate • SBA loans have not demonstrated the same propensity to prepay as MBS in response to interest rates changes. In most cases they are not interest rate sensitive relative to prepayment speeds. • SBA loans are commercial loans which by definition will experience prepayment mortality due to business cycles and demographic factors.
The SBA 7(a) Pool Market Constant Prepayment Rate • Coastal has studied prepayments extensively for over 20 years using data from Colson Services Corporation, the fiscal and transfer agent for the SBA. • Historically, the prepayment data for each month was similar to the preceding month causing the life CPR to remain rather constant. However, in periods of higher volatility like those seen in the “loose credit” period of the mid-2000s to the “no credit” period of 2008/2009, a shorter prepayment series is appropriate.
The SBA 7(a) Pool Market Constant Prepayment Rate • Because SBA securities are subject to prepayments and normally trade at a premium, knowledge of their prepayment characteristics is important. • SBA prepayments are not influenced by the same drivers as MBS prepayments. • SBA prepayments had exhibited a fairly consistent and level pattern until the period from early 1998 to the end of 1999. After spiking in the easy credit days earlier this decade, prepayments are now at or near record lows.
The SBA 7(a) Pool Market Reasons for Relatively Stable CPRs • SBA Pool Structure: • - Loans are normally geographically diversified • - Industrial diversification • - Adjustable rates remove the incentive to refinance as rates move up or down • - SBA program is designed to provide longer term financing than is normally available to borrowers
The SBA 7(a) Pool Market Reasons for Relatively Stable CPRs • Investors should not shy away from premium SBA securities where additional yield can be gained. • Building a diversified portfolio of SBA securities can substantially reduce the effect of prepayment risk.
The SBA 7(a) Pool Market Prime & LIBOR • Prime and LIBOR are two of the most favorable indices available to variable rate security investors. • Aside from the aberrations caused by the Credit Crunch, in both rising and falling rate environments… • - Both indices have historically tracked Fed Rate changes.
The SBA 7(a) Pool Market What Is The Primary Issue To Consider When Deciding to Invest In SBA Pools? Premium Risk
The SBA 7(a) Pool Market Premium Risk • Understanding and measuring premium risk is the first step towards managing that risk. • Coastal has built such a mechanism - CSBA. CSBA allows investors the opportunity to analyze CPR speeds using historic vectors.
The SBA 7(a) Pool Market Premium Risk • In order to manage risk and earn highly predictable yields: • - Diversify the portfolio. • - Spread premium exposure over multiple loans. • - The larger your “critical mass,” the better chance that you will mirror the universe of prepayments on SBA Pools and attain predictable results.
The SBA 7(a) Pool Market Premium Risk • In order to manage risk and earn highly predictable yields: • - Diversify the portfolio. • - Spread premium exposure over multiple loans. • - The larger your “critical mass,” the better chance that you will mirror the universe of prepayments on SBA Pools and attain predictable results.
The SBA 7(a) Pool Market Pool Maturity Ranges • Working Capital Loans • Most loans with maturities of seven years or less • Average pool size: $3.07mm • Intermediate Maturities • Predominantly machinery and equipment loans • Maturity range of 11 – 15 years • Average pool size: $7.46mm • Long Maturities • Real estate backed loans • Maturities of 16 + years • Mandatory 5/3/1 prepayment penalty • Average pool size: $8.63mm
Disclaimer Nothing contained herein is an offer to sell or the solicitation of an offer to buy any financial instrument. The opinions and recommendations presented do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. Investors must make their own independent decisions regarding any securities or financial instruments mentioned herein and seek professional advice, including tax and accounting advice. Any indications of market valuation contained herein are based on current information that we consider reliable, but we do not guarantee it is accurate or complete and users should make whatever additional determinations of market value they deem appropriate. All assumptions, opinions and estimates constitute Coastal Securities, Inc.’s (CSI) judgment as of this date and, along with prices and yields, are subject to change without notice. Past performance is not indicative of future results. The yield and/or average life shown on loans, SBA pools, CMOs or mortgage backed securities consider prepayment assumptions that may or may not be met. Changes in prepayments may significantly affect yield and/or average life. CSI does not accept orders or instructions transmitted via email or left on any phone voice or text mail system. Please be aware that communications received by or sent from our email system are not confidential and subject to review by supervisory personnel.
