There’s robust demand from institutional investors for full faith and credit floating-rate securities, and 7(a)s fit the bill. More good news for bond portfolio managers: The prepayment activity for 7(a)s is highly uncorrelated with that for mortgage-backed securities (MBS). Part of that is due to the complexity of commercial lending I mentioned earlier, but most of the difference is based on SBA floaters’ rates staying on-market. As of this writing, 7(a) yields have come down 100 basis points (1%) since last fall, with more cuts expected later this year. In this sense, the small business borrower is anticipating some further rate relief. SBA prepayments do, in fact, tend to slow down in lower rate environments. Two-Way Street Let’s look at an example of the two-sided market for 7(a) loans and pools. Recently, Stifel offered SBA 530726, a 10-year quarterly reset pool collateralized by equipment, at a price of 108.625. Assuming a prepayment speed of 15% per year, which is close to the historical rate for equipment pools, the yield will be fed funds plus 52 basis points. Here’s where the future shape of the yield curve may help the attractiveness: For the past decade, fed funds plus 0.52% has out-yielded the 10-year treasury note by an average of 15 basis points. The advantage grows geometrically if we look at just the past three years, which, of course, include the historically long inverted yield-curve era. On the sell side, the raw materials for the pool are 129 10-year equipment loans with an average guaranteed balance of $338,000 and a borrower’s rate of prime plus 1.85%. The loans were sold individually into the secondary market at an average gain on sale of $28,300. The lender/seller retains the full note rate on the unguaranteed portion, plus a 1% servicing fee on the sold balance. For many community banks, both commercial lenders and bond portfolio managers benefit from the SBA’s 7(a) program. With the prime index rate off its peak of 2024 but with projections to stay relatively elevated, sellers and investors have an opportunity to ride along the high plains to fee income, servicing income, attractive bond yields and price stability. Jim Reber, CPA, CFA (jreber@icbasecurities.com), is president and CEO of ICBA Securities, ICBA’s institutional, fixed-income broker-dealer for community banks. 7 In Touch
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