October 15, 2018
SBA activity last week was slower than recent levels due to several factors. The DCPC auction last Thursday, which included 20yr and 25yr terms, priced at tighter spreads than the prior month, but offer significantly higher debenture rates of 3.77% and 3.89%. Investor activity is expected to also pick up in floating rate equipment pools as yields on SBA floating rate pools moved higher over the last month and are likely to move higher if the Fed raises rates later this year. Most vintages of both equipment and real estate SBA 7(a) pools posted slower speeds this month than for August and September.
Floating-Rate 7(a) Pools
- Investors have remained active in floating rate equipment pools offered at par and also those with premium pricing. Ten-year WAM equipment-loan pools should attract investor interest due to the cash flows from shorter-amortization schedules: many competing floating rate alternatives offer minimal or no principal cash flows for a significant interval after issuance.
- Pricing levels on SBA floating pools with uncapped quarterly resets indexed to Prime offer attractive yield opportunities versus interest bearing cash and fed funds returns and also when compared to other floating rate bond alternatives.
- Yields ranging from approximately 2.70% on par pools and 3.00% on premium pools are currently available. With 90-day Treasuries trading at 2.27%, this represents an opportunity to buy current pay bonds with a par handle price at a spread of 43bp based on the 90-day reset.
- The market is currently pricing in over a 75% chance of another 25bps hike by the Fed at their meeting in December and 12 of 16 Fed members are projecting another hike this year, which should continue to drive demand in floating-rate SBAs.
- With another 25bps hike in fed funds, floating rate SBA equipment pools would yield approximately 3.20% using the current prepayment vector, a higher yield than a 10-year Treasury bond (3.16% yield) combined with the floating rate benefits of lower price volatility and effective duration.
Fixed-Rate DCPC Pools
- Fixed-rate DCPC pools and SBIC fixed-rate debentures remain attractive as they offer superior convexity profiles to most residential MBS alternatives, while offering comparable yields and spreads.
- The October DCPC auction last week included 20yr and 25yr terms.
- Yield spreads versus Treasuries tightened in the October auction compared to the prior auction and the last several months.
- The 59bp spread over Treasuries for the 20yr DCPC auction in October tightened 5bps from the prior month, while the 25yr term tightened 5bps to 71bps.
- Pool issuance in the October auction was mixed compared to the previous auction. Issuance for the 20yr term declined to $260M, while the 25yr term increased to $80M.
Government Guaranteed Loan Trading
Government-guaranteed USDA agricultural loans and SBA loans actively traded to financial institutions last week. As has been the case for some time, supply and not demand limits loan trading volumes.
Dan Stimpson, CPA
Senior Vice President