A Word from Arne
As the saying goes, “Time flies when you’re having fun.” As of March 1st, Holtmeyer & Monson is celebrating 36 years of serving government-guaranteed lenders. It really does seem like almost no time since Gene Holtmeyer and I packaged our first SBA loan from our office in Minneapolis. Back then, we had a handful of clients and no staff. Many things have changed a lot, but not the gratification, pleasure and lasting relationships that come from being able to provide a very high level of service to all of our clients. The joy and satisfaction it brings us just keep on building – and man, is that ever fun. I want to express a big “Thank You” to everyone we work with. All of us at H&M truly value the opportunity, and we look forward to providing you with an unparalleled professional service for many years to come.
Another notable passage of time is the retirement of Cam Fine, who has led the Independent Community Bankers of America (ICBA) as its President and CEO for the last 15 years. Cam has been a strong advocate for community banking during his tenure. All of us wish Cam well as he retires after the ICBA annual convention in Las Vegas (March 13-17). The incoming President and CEO is Rebecca Romero Rainey, a career community banker from Taos, New Mexico. We extend her our warm congratulations.
Proposed 2019 SBA Budget
President Trump recently submitted his FY 2019 budget proposal for the SBA. Embracing the notion that access to capital is the lifeblood of small businesses, the proposal contains some key items that we’d like to highlight here:
- $30 billion 7(a) authorization cap
- Increase in the maximum ongoing service to .625% for loans of $1,000,000 or greater and loans less than $1,000,000 remain subject to a .550% fee
- Elimination of all borrower fee waivers not required by law
- Increased guaranty fee on loans of $1 million or greater
- Lift in the SBA Express limit from $350,000 to $1,000,00
These changes are in the proposal stage, and much discussion and compromise will take place before the SBA budget is finalized. We will keep our clients and readers well informed as the budgetary process is finalized.
Please call if we can help your organization address any SBA-related questions. Holtmeyer & Monson provides out-of-house SBA lending services for community financial institutions – from loan packaging and closing, to securitization and sale, through portfolio servicing – and has been a Preferred Service Provider of the ICBA since 2006. We welcome the opportunity to assist you.
Who Moved My Step-Ups?
Population of agency bonds is evolving
by Jim Reber, President and CEO, ICBA Securities
Not so long ago, a wildly popular variety of government agency bonds was struggling to get to market fast enough to meet investor demand. Chances are your community bank owned some, or a lot, of these bonds, known as “step-ups.” Lately, the ever-changing dynamics of supply and demand have made the build-out more difficult and the attractiveness less so. Since we’re in the community banking business, and most everything we touch is somehow cyclical in nature, it bears examining why step-ups are at least temporarily on hiatus and what could spark their triumphant return.
But before we do, let us revisit the basic structure. These step-ups are issued by the usual suspects: Fannie Mae, Freddie Mac and the Federal Home Loan Bank. They have good liquidity, are pledgeable and are 20 per risk weighted, so they meet all those safety and soundness criteria. Their maturities can vary from three years to 15. Their “lockouts,” which are the periods from issue until the first call date, can be as short as three months and as long as three years. The one thing they have in common: a stated interest rate, or coupon, that will rise in the future if the bond isn’t called by the issuer.
Beyond the promise of a higher rate in the future (if the bond still exists), step-ups can have very different structures. For one, the steps can be one-time-only (which is comparatively rare), or they can be multi-steps. For another, the height of the steps can be miniscule (as small as 12.5 basis points, or .125 percent, annually) or as large as two percent annually. For still another, most step-ups can be called at any interest payment date, but a few have one only call date. Your broker should show you all the possible outcomes during the pre-purchase phase.
In the end, the reason step-ups have appeal to community banks is that they provide protection against rising rates. Portfolio managers realize that they are sacrificing yield today for some potential upside later. The trick is to buy enough yield in the future to make up for the lost revenue today, which involves guesswork, as the following illustrates.
In March 2017, Fannie Mae issued a fixed-rate bond that matured 3/29/2021 with a coupon of 2.125 percent. It also issued a step-up that matured 3/29/2022 with a beginning coupon of 1.75 percent. Both bonds were callable in six months, which meant September 2017. In fact, both were called, so the first investor’s holding period yield was 37.5 basis points higher for the same six months. The breakeven date was March 2020, which now will never happen.
With that as a background, let’s examine the difficulty of launching step-ups in today’s market. As short rates rise relative to longer rates, the underwriters struggle to rob enough coupon from the front end of the cash flows to make the back coupons attractive to risk-averse investors. Remember that portfolio managers are comparing fixed-rate callables with step-ups, as we saw in our example. In the two years between January 2016 and January 2018, the yield curve between one and 10 years flattened 100 basis points.
To demonstrate, we can refer back to our Fannie Mae step-up from 2017. That bond, which you remember was called in September 2017, would have had a terminal coupon of 4.00 percent had it lasted five years. Today, in a much higher short-term rate environment, a similar step-up would begin with a coupon of about 2.00 percent but would have a terminal coupon of only 3.00 percent. Plenty of portfolio managers are deciding that a fixed-rate callable is a better option at the moment.
Proof in the underwriting
Now let’s look at some numbers for evidence. Back in the steep curve days of say 2011, nearly half of all agency issues had some type of stepped-up coupon structure. Even as late as a year ago, nearly a quarter of the new bonds had built-in yield protection. In December 2017, step-ups accounted for less than five percent of newly hatched bonds.
Community banks in general own fewer agencies than before. In the past six years, the sector’s weightings have gone from about 18 percent of the total portfolio to about 11 percent today. I would suspect that given the continued rising demand for well-structured mortgage products and high-quality municipal bonds, and their attendant shrinking spreads, agency bonds can make a comeback among community banks—especially when we see the yield curve begin to steepen. The evolution of the agency bond market will continue to respond to investor demand, and that will include step-ups.
Jim Reber is president and CEO of ICBA Securities and can be reached at 800-422-6442 or firstname.lastname@example.org.
Vining Sparks, ICBA Securities’ exclusive broker, offers full-service bond accounting at attractive prices. Vining Sparks currently performs these services for nearly 500 community banks, and a customized report menu is available. To learn more, contact your Vining Sparks sales rep or visit www.viningsparks.com.
Clarifying the Credit Elsewhere Rule
Provisions of SBA Standard Operating Procedure (SOP) 50-10 5(J) became mandatory as of January 1, 2018. One of the most significant changes now in effect involves the Credit Elsewhere Rule. Embodied in the SBA procedures for many years, the revised Rule now requires SBA lenders to certify that SBA loan applicants do not have the ability to obtain requested funding on reasonable terms through conventional sources. The lender’s credit memo must contain adequate substantiation that the financing cannot be accomplished without SBA support. Additionally, SBA has clarified the list of factors that a lender may NOT state as the sole basis for making use of SBA loan programs. Inappropriate sole-use factors include the lender’s dependency on secondary market sales for liquidity and the fact that the SBA guaranty will allow the lender to exceed its legal lending limit.
Changes to the SBA standard operating procedures generally cause some confusion for a period of time after they’re issued. Please call your Holtmeyer & Monson Account Executive for any clarifications.
Two topics: (1) On December 14th, the prime rate was increased to 4.50%. This rate increase will take effect on 01-01-18 for SBA accounting purposes. (2) SBA lenders may unilaterally – without SBA approval - extend loan maturities at any time before the subject loan or line of credit reaches maturity. After maturity, lenders must receive SBA approval for maturity extensions.