SBA Lending Matters Newsletter
A Word from Arne

In business, as in life, change is inevitable. The U. S. Small Business Administration is no exception. On April 12, 2019, Linda McMahon stepped down as the Administrator of the SBA to chair the America First Action super PAC. During her two years of service to the SBA, Linda was a strong advocate for small businesses and their critical access to capital. We thank Linda for her service, and wish her well in her new endeavor.

Ms. McMahon has been replaced by Acting Administrator Christopher Pilkerton. Chris brings a strong career history of financial and legal experience to the SBA. All of us here at Holtmeyer & Monson look forward to working with Chris to serve our nation’s small businesses.

Other News to Note
The Trump administration released its FY2020 budget on March 11, proposing cuts in federal spending. Particularly noteworthy is a provision that would increase fees charged in the SBA 7(a) loan program to cover the government’s cost of subsidizing the 7(a) loan guarantees. At present (and since 2005), the 7(a) program has operated on a “zero subsidy” basis, meaning that the interest and fees paid by borrowers and lenders offset what the government paid to guarantee the loans against default. In other words, the program has been breaking even.

However, the proposed 2020 budget includes a “positive subsidy” of approximately $99 million. In general terms, this means the administration estimates that the government’s cost to guarantee 7(a) loans would outweigh any estimated returns the program might generate – by $99 million. The SBA believes it needs to collect this amount in fees from small business borrowers and lenders, in addition to the fees already being collected.

This is curious to us in the industry. By all published indications, the 7(a) portfolio has never been in better shape. Plus, over the past eight fiscal years the SBA has returned to the Treasury $3.2 billion in excess fees that it collected from borrowers and lenders. According to the National Association of Government Guaranteed Lenders (NAGGL), this suggests that the model used in SBA’s subsidy calculation has been consistently wrong.

The subsidy calculation is a very complex. We know that it is based on expected collections received from loan repayments, interest and fees – excluding administration expenses – as well as estimated risk of defaults and the government’s cost of borrowing (at Treasury rates). However, the model has not been clearly explained to the people most affected by it.

Lenders are currently working closely with Congress to ask both the Office of Management and Budget (OMB) and SBA to explain the subsidy calculation in detail, along with the weighted assumptions used to create it. Any Congressional action on the proposed FY2020 budget proposal must be taken by October 1, 2019 to keep the 7(a) program running. Two available options are either for Congress to allocate more funding to the 7(a) program, or for the fees paid by borrowers and lenders to increase (the solution preferred by the SBA). We will continue to follow the issue, and keep all of our readers informed as to current developments.

If you run into any questions or matters that you’d like us to clarify, please don’t hesitate to reach out. In addition to supplying answers and explanations, H&M can also serve as your out-of-house SBA loan department. We are a Preferred Service Provider of the Independent Community Bankers of America, and we’re happy to be a resource you can rely on to fill any SBA-related needs.

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Featured Article

Short and Sweet
Cash-management instruments have relative value today

by Jim Reber, President and CEO, ICBA Securities

“What if?” How many times and how many ways has someone started a conversation like this with a community banker?

Borrower: What if you hold the title on my ’83 Camaro as additional collateral?
Examiner: What if Fannie Mae and Freddie Mac walk from their debt obligations?
Depositor: What if you pay me an extra five basis points on my $5,000 CD?
Auditor: What if your Held-to-Maturity bonds go further underwater?
Lender: What if we put a 6% cap on this floater?
Investor: What if you bought my 25 shares at three times book?

What if you could purchase a full faith and credit instrument that pays monthly principal and interest, adjusts based on prime with no caps, has little or no prepayment risk, and out-yields the 10-year Treasury?

Highly valued
All of the above qualities currently exist in a Small Business Administration (SBA) 7(a) loan pool. These have long been the choice of investors looking for additional yield on the very shortest end of the maturity spectrum. Most 7(a) pools adjust with the calendar quarter, although there are some monthly adjusters available. It is true that there are no rate caps, either periodic or lifetime. All these factors make SBA securities the most rate-sensitive of any in the market.

There has been a lucrative two-way market for SBA pools for at least 30 years. Community bank lenders like the ability to make loans to qualifying borrowers that don’t quite fit the standard parameters. They also like the ability to sell the guaranteed portions of the loans (usually 75%) and retain the servicing and the relationship. And they especially like selling them at big premiums. By the end of 2018, the balance on outstanding 7(a) pools was over $32 billion, which was a high-water mark for the agency. Nine out of 10 loans originated are sold in the secondary market to a consortium of SBA poolers.

Response to demand
To a community bank investor, the rub with the pools has historically been the high purchase prices. All of the characteristics, except for the premiums attached, are prized by risk-averse portfolio managers. While there are ways to manage those prepayment exposures, there’s no getting around the fact that an instrument that costs 110 cents on the dollar or more, and can prepay at the borrower’s behest, contains risk.

In response, there are now SBA securities being issued and available at prices very near par. As part of the pooling process, certain amounts of the loan rates can be stripped off for alternative uses, leaving just enough coupon pass-through on a given bond to result in a market price between, say, 99.50 and 100.50.

Yield and price stability
You may have heard that the yield curve is relatively flat. In the good news/bad news environment in which community banks invest, this is a concrete example. The positive is that short-term bonds yield about the same as longer-term bonds, so today you don’t have to extend your maturities for reasonable returns. The negative is that a flat curve is usually followed by a secular drop in rates, more so on the short end. True floaters, like SBA 7(a)’s, will be the first to see their yields fall.

More to the point, it’s totally uncertain that any rate cutting will happen in the near future. Macro indicators like GDP, employment and inflation aren’t pointing to recessions any time soon. And just as the current level of fed funds is far below the normal stop-out point in a rate hike cycle, maybe we’re in for a protracted period of stable rates.

If so, then the current yields on these 7(a) pools are quite handsome. It’s not too difficult to achieve a return of around prime minus 275 basis points (2.75%), which as of this writing equates into a true yield of about 2.75%. Where’s the value in that?

For starters, the 10-year Treasury note has averaged about 2.65% this year. For closers, these par-level bonds have virtually no prepayment risk and very little price risk, are pledgable, and produce monthly cash flow.

What if you committed a portion of your securities portfolio to investing in low premium SBA 7(a) pools?

Jim Reber is president and CEO of ICBA Securities and can be reached at 800-422-6442 or [email protected].

Vining Sparks, ICBA Securities’ exclusively endorsed broker, is one of the largest SBA 7(a) poolers in the country and is interested in purchasing guaranteed portions of SBA loans directly from your community bank. For more information about selling SBA guarantees, and to view its inventory of fixed- and floating-rate SBA pools , contact your Vining Sparks sales rep or visit www.viningsparks.com.

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Regulatory Corner

Revised Procedure – Borrower Change of Ownership

As of April 1, 2019, SBA lenders may not unilaterally approve any adjustment to or change in the ownership of a Borrower, including a change in percentage of ownership, for 12 months after final disbursement on any 7(a) or 504 loan. Such changes now require SBA’s prior approval, which must be obtained by submitting a request to the appropriate Commercial Loan Servicing Center (CLSC). The request must include the reason for the change(s), the details of the requested action, along with the recommendation of the SBA Lender. The appropriate CLSC will make its determination after:

a.  Verifying that the proposed change of ownership of the borrower complies with limitations on the aggregate amount of SBA portions of all loans to a borrower, including affiliates; and

b.  Verifying that no prior loss to the government has been caused by the new owner(s) or any business owned, operated or controlled by the new owner(s).

Please feel free to contact Penny Newbauer or Arne Monson at (800) 340-7304 if you have a specific question. We will be happy to provide guidance.

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SBA Hot Topic
Effective March 12, 2019, a revised IRS Form 4506-T is required to request tax transcripts used to verify business financial information that must be submitted with SBA loan applications. As part of our services, H&M requests/delivers transcripts very early when preparing applications, to avoid potential exceptions later on.
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