SBA Lending Matters Newsletter
A Word from Arne

Summer is drawing to a close, the kids are headed to school again, and the government is nearing the end of its fiscal year. It’s a good time to review the SBA 7(a) program operations.

Usage of the program has increased in recent years, to the point that the guaranty authority – the amount anticipated to meet current borrower needs – stands at $26.5 billion. Given the vigorous growth in SBA 7(a) lending, we in the industry predict that the program’s funding requirement for the next fiscal year will be about $29 billion. Make no mistake, a vibrant SBA lending program is a good thing for small business borrowers who are seeking much-needed capital. However, the US Congress, which appropriates taxpayer dollars to fund the SBA, has a legitimate concern over the trending growth pattern of the 7(a) program.

More Oversight On The Way?
Whenever a government program experiences rapid growth, Congress necessarily requires greater oversight, and this is the case with the SBA. Congress has advised that more oversight will be needed in order to increase the guaranty authority for the coming fiscal year. And additional oversight is expensive. Currently, the SBA operates at what is known as a “zero subsidy” level. This means that the agency’s operations – and potential losses – are funded through guaranty fees and ongoing service fees.

“Zero subsidy” is a great concept, and Congress is extremely supportive of the SBA and its programs. Elected officials recognize that the programs are working very well to deliver much-needed capital to small businesses that are unable to secure conventional financing. As the programs continue to expand, funding options will be wide ranged and various. Nevertheless, greater Congressional oversight is going to be a reality. Rest assured that we will keep our readers informed as further discussions between Congress and the SBA develop.

And, as always, if you have questions about this or other issues, please reach out! We welcome your inquiries at Holtmeyer & Monson, and we are glad to share any knowledge we can on matters of concern to small business lenders. It’s something we do every day in our roles as a qualified SBA Lender Service Provider and a Preferred Service Provider of the Independent Community Bankers of America (ICBA). We serve as the out-of-house SBA loan department for many community banks, and can provide the same services for your institution.

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Featured Article

The Long and the Short of It
SBA pools can create an instant barbell
by Jim Reber, President/CEO, ICBA Securities

Military strategists are always reminding those under command to “guard the perimeter.” Ensuring that the outside boundaries of an army’s territory are secure is essential in protecting its position. Great attention, and resources, are dedicated to guarding the flanks. In investment portfolio parlance that translates into creating reasonable performance out of short-term and long-term investments (and here’s the trick) simultaneously.

For the past eight years, the shape of the yield curve (steep) and the policies of the Federal Open Market Committee (“accommodative”) have created an environment in which all yields on investments popular with community banks are compressed in absolute terms. Some portfolio managers have been tempted to stretch beyond their duration comfort zones to attain yield. This column, fortuitously, suggests a strategy that many community bankers have employed that produces an acceptable risk/reward tradeoff. And it all involves securities guaranteed by the full faith and credit of Uncle Sam.

Short, sweet
The Small Business Administration (SBA) issues securities backed by loans it guarantees, made to qualifying small businesses. The flagship program, 7(a), produces true floating rate securities. These 7(a)s are unique in that they float based on Prime, either monthly or quarterly, and have no caps whatsoever. The typical investor of these pools wants a very short duration, and some (i.e., not a lot of) current yield.

The risk in these pools is the price. Most have substantial premiums, often over 10 points, and since they can prepay at any time, the investor could conceivably have its yield hammered if a number of loans prepay sooner than expected. Two ways to protect yourself are to: (1) Purchase newly-issued pools, as history shows that new SBA loans have several years after origination in which payoffs are very slow, and (2) Purchase large pools that have a limited number of large credits. The seller should be able to produce a detailed loan list for a given pool. 

On the other hand
And now for you fixed-rate fans, the SBA also issues bonds known by the alphabetic DCPCs, which are backed by the guaranteed portion of SBA 504 program loans. These have either 10- or 20-year maturities, so their average lives can be quite long. This is especially so since they contain prepayment penalties for the first five years of their term, which effectively shuts down all prepay activity in the early going.

A new 20-year DCPC will have an average life of about six years initially. A feature that makes these a good pairing with 7(a) pools is that they can be purchased with little or no premium, so that the average book value of a combination of the two can be more palatable to a community banker. Like their floating rate brethren, they are quite liquid and generally pledgeable. Because of their longish durations, they are often viewed as municipal-bond surrogates for institutions that can’t benefit from tax-free bonds or simply wish to layer in some zero-percent risk weightings.

What to expect
A recent barbell strategy utilizing equal amounts of floating- and fixed-rate SBAs that has been employed by community banks had the following metrics:

Average coupon: 2.96%
Average book price: 107.105
Average yield: 1.62%
Average duration:  3.44 years

There are two additional points to put into the hopper. The first is to remind you that half of these investments are floating rate, so that their yields will improve immediately whenever Fed Funds (and Prime) rise. The second is that a three-year Treasury note yields about 0.90 percent at the moment, so you would be significantly improving your income in a similar duration vehicle, with no drop in credit quality.

A final reminder is that, for you 7(a) lenders, a sellers’ market is in session. Premiums have remained near their all-time highs, given the increased demand for the floating rate pools and the slow prepayment histories since 2009. If you have one or more 7(a)s in your bank’s loan portfolio, I strongly recommend asking your favorite broker for a bid. Fee income is a significant part of any bank’s strategy of protecting the perimeter.

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

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See for yourself
ICBA Securities, through its exclusive broker Vining Sparks, models barbell investment strategies for community banks each week. Contact your Vining Sparks rep or Jim Reber for the latest DCPC/7(a) barbell model.

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Regulatory Corner

SBA Simplifies Affiliation Rules
Affiliations can be a key factor when determining a borrower’s eligibility to use SBA loan programs. Effective
07-27-16, SBA simplified affiliation rules for many programs, 7(a) included. Several affiliation criteria now apply, and it’s important to remember this whenever an applicant may be subject to an affiliation:

“Concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both”.

As we process SBA applications we perform specific tests to confirm various types of affiliations: Affiliation Based on Ownership, Affiliation Arising under Stock Options, Convertible Securities and Agreements to Merge, Affiliation Based on Management, Affiliation Based on Identity of Interest. One of the first tests we perform is an affiliation analysis. If a borrower does not meet the affiliation test(s), we will terminate the application.

Please call your Holtmeyer & Monson representative for additional details on this issue.

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SBA Hot Topic
Effective 10-01-16,SBA will increase the on-going service fee on 7(a) loans and Caplines from the current level of 0.473% to 0.546%. SBA will also eliminate the waiver of this on-going service fee on loans of $150,000 or less, so that all SBA guaranteed 7(a) loans and Caplines AUTHORIZED after 10-01-16 WILL BE subject to the increased fee. Please get your SBA applications in a position to be authorized prior to 10-01-16.

 

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