April 9, 2018
While most bond market sectors languished last week and portfolio managers eased into a new business quarter, the SBA sector mustered a fair amount of business relative to prior weeks. Speculation about the number of further rate increases always seems to lead to questions about floaters, and this kind of attention resulted in some 7(a) trades. Meanwhile, fixed-rate SBAs attracted some new money to the sector with a combination of elevated supply from the monthly DCPC auction and the recent SBIC auction. Yield spreads versus Treasury and swap curves widened by slightly greater amounts than many competing products during the last two weeks.
Floating-Rate 7(a) Pools
- Recent market changes revitalized interest in floaters. The recent boost to SBA yields via short-term rate increases pushed them in line with some of the shorter fixed-rate alternatives, and widely-held expectations for one or more further increases now tilts the balance toward floaters.
- SBA floater inquiries remained biased toward recently-issued equipment-loan pools.
- Most new equipment pool offering prices are in the 113 to 114 price range, with yields over 2.10% at a 12 CPR.
- Par handle pools continue to attract attention from first time SBA buyers looking for alternatives to other floating-rate bonds.
Fixed-Rate (DCPC and SBIC) Pools
- While investor aversion to negative convexity remains strong, the advantages of structures with locked out principal cash flows shrank as the curve flattened. This change to total return profiles along with the desirability of current cash flows for many investors is beginning to attract focus from some traditional buyers of multifamily products and some CMO structures.
- The ten-year stated final of the SBICs limits extension risk and prepayment patterns are loosely correlated to interest rates relative to residential mortgages. Some of the recent demand for SBICs has come from investors that already find value in the multifamily sector. Even at a CPR of zero, SBICs offered at current levels offer excellent yield spreads over swaps and Treasuries, and prepayment patterns suggest they will have average lives much closer to six years.
- Last week the monthly DCPC auction only included a twenty-year amortizing term. The wider spread relative to the four prior auctions pushed relative value back in line with cheaper levels not seen since the end of 2017.
Government Guaranteed Loan Trading
- Demand for government guaranteed loans remains strong enough that supply represents the primary limit to the volume traded.
- The pace of DCPC loan origination remains slow relative to last year, likely limiting the issuances at upcoming auctions.
Weekly volume for the SBA sector held up better than many others last week. 7(a) floaters received extra attention, as did most floating-rate structures based on the expected trajectory of short-term rates. The monthly DCPC auction added to the recent boost of supply for fixed-rate SBA products, and the tightness of supply for these earlier in the year has at least temporarily been allayed.
Director of Investment Product Strategies