February 12, 2018
As we have observed over the past few weeks, activity in the SBA market continues to be squarely centered on fixed-rate DCPC structures and purchases of USDA loans on the secondary market. Last week investors added DCPCs from the February auction. Although floating-rate SBAs continue to trade, the majority activity is in par handle floating-rate issues. Four months of SBA floating-rate prepayment activity have passed, giving the market a better understanding of the new cash flow distribution methodology and the market impacts.
Floating-Rate 7(a) Pools
- SBA floating-rate securities continue to be a strong alternative to mitigate interest rate risk in a rising rate environment. Recent activity has focused on the addition of “par” SBA pools, priced at levels below 101. “Par” pools offer yields above that of Fed Funds, with limited premium risk. Levels observed last week were pools priced just shy of 101, yielding just north of 1.75%.
- Four prepayment cycles have passed since the SBA announced and their master servicer Colson implemented important changes to procedures for distributing cash flows from 7(a) loans to pools. These cash flow changes resulted in an upward shift in pool CPRs. The timely payment of all principal and interest, the rate reset mechanism, and all the features of the product remain the same. While the SBA created a need to adjust prepayment assumptions, the sector retains the key characteristics that made and should continue to make SBA floaters a highly desirable defensive asset. For further information regarding recent prepayment metrics regarding floating-rate SBAs, please review our latest Strategic Insight.
Fixed-Rate (DCPC and SBIC) Pools
- Demand for fixed-rate SBA securities continues to be healthy, with investors adding DCPCs from the latest auction. The February auction only included a 20-year term that was just under $325 million, $59 million more than the January auction. The pool is comprised of 363 loans, with a fixed coupon of 3.22%, 30 bps greater than last month. The spread to Treasuries was comparable to last month at 35 bps.
Government Guaranteed Loan Trading
- Loan trading activity continues to be healthy, as depository managers have been managing their government guaranteed loan portfolios. Strong loan trading activity should lead to the creation of new SBA pools in the near future. In addition, USDA loans continue to be actively traded and have come to market with a variety of structures. Most recently, loans available have ranged between 5-10 years, offering yields between 2.0% and 3.0%.
Although fixed-rate loan originations that back DCPC debentures has tailed off since last year, the latest DCPC auction was larger than the previous two pools. Going forward, strong demand should continue if supply is limited due to lower fixed-rate origination activity. In addition to DCPCs, depositories have been very active purchasing USDA loans for their balance sheets.
Greg Roll, CFA
Senior Vice President