An Introduction to Small Business Administration Floating Rate Securities

Transcription

1 An Introduction to Small Business Administration Floating Rate Securities March 2018 Benjamin M. Clark Portfolio Strategies Group FTN Financial

2 Outline 1. SBA securitization programs 2. Brief history of the 7(a) program 3. Current trends in 7(a) pool issuance 4. SBA s 10/2017 procedural rule change 5. Measuring and managing prepayment risk 6. Relative value Disclaimer is located on the last page of this presentation. 1

3 SBA Securitization Programs

4 Securities Backed By SBA As an official Agency of the U.S. Government, securities backed by the Small Business Administration carry an unconditional full faith and credit guarantee for timely payment of principal and accrued interest Fixed Rate: SBIC & SBAP Programs SBIC 10 year final, non-amortizing, semi-annual interest, periodic principal from paid off loans SBAP 10 & 20 year maturities, amortizing, semi-annual P&I Floating Rate: SBA 7(a) Program 7(a) program loans are pooled by assemblers Amortizing with maturities up to 25 years Quarterly or monthly adjust, no caps, tied to Prime or SBA Libor 3

5 History of the SBA 7(a) Program

6 History of the SBA 7(a) Pooling Program Established by Small Business Secondary Market Improvements Act of 1984 Floating & fixed rate pool issuance Over $102B in pool issuance to date $33.2B+ in unpaid principal balance $6.7B five year average annual issuance $8.9B in 2017 Record Year 5

7 Fundamentals US Govt. guaranteed for timely payment of P&I DTC Eligible Monthly or quarterly adjusting Nearly all have no periodic or life caps Nearly all current issuance tied to WSJ Prime Monthly P&I 6

8 Fundamentals Full Faith & Credit Duration of One Year or Less Fixed GNMA MBS Treasury Notes/Bonds GNMA 1Yr ARMs Treasury Bills SBA 7a Pools Annual Reset ARMs Variable Rate CMOs Variable Rate ABS Uncapped 7

9 SBA 7(a) Pool Issuance Annual SBA 7(a) pool issuance as of 2/2018 Several record issuance years in a row - could surpass $10B in 2018 $9,000,000,000 $8,000,000,000 $7,000,000,000 $6,000,000,000 $5,000,000,000 Average ( ): $4,421,425,436 $4,000,000,000 $3,000,000,000 $2,000,000,000 $1,000,000, Source: SBA 8

10 Current Trends in Pool Issuance

11 Current Trends in Pool Issuance Adjust Term 97.5% quarterly Major WAM buckets 94% of 2017 Issuance 8-11 Year (Equipment/Working Capital) 39% of 2017 issuance 21+ Year (Long Real Estate) 55% of 2017 issuance Par-priced pool formation roughly half of recent long real estate issuance (21+ yr original WAM) Source: Colson Services & FTN Financial 10

12 SBA s 10/2017 Procedural Rule Change

13 10/2017 Rule Change Retained Pool Principal SBA Pools are formed as a modified pass-thrus 1. Terms of pooled loans can differ from the security s terms 2. This mismatch creates excess amortization at the pool level* 3. Underlying loans often amortize at a faster rate than the pool s balance 4. The sum of current balances at the loan level are often less than the pool s trading balance On 10/16/2017, the SBA changed the way this excess amortization is remitted to pool holders *NOTE: Excess amortization is held in the SBA s Monetary Reserve Fund and is guaranteed by the FF&C of the US government 12

14 Before & After the Rule Change Before the rule change: Excess principal accumulated over time and was paid out when last loan paid off or pool matured A 2004 rule change designed to address this was not fully implemented After the rule change: Retained principal within each pool was reallocated (pro rata) to the unpaid loans in the pool As loans pay off moving forward, they will also carry their allocated share of the excess 13

15 Example Two Loan Pool with $500K Excess Pool Details Current Trading Balance = $1,500,000 Current Underlying Loan Balance = $1,000,000 Excess Pool Principal = $500,000 Loan Details (2) Loan 1 Balance = $400,000 40% of total balance, carries $200K of excess Loan 1 represents $600,000 of the pool balance Loan 2 Balance = $600,000 60% of total balance, carries $300K of excess Loan 2 represents $900,000 of the pool balance 14

16 Impact of Rule Change: Summary The impact of this rule change has been higher CPRs for certain vintages New issue pools have been largely unaffected by the change contain little to no accumulated excesses Market has become bifurcated 1. recent/new issuance 2. seasoned pools 15

17 3M CPR Impact to CPRs by Year of Issuance 3M CPRs by Year of Issuance: Equipment/Working Capital Pools Year of Issuance Sept 3Mo CPR Oct 3Mo CPR Nov 3Mo CPR Dec 3Mo CPR Jan 3Mo CPR Feb 3Mo CPR Mar 3Mo CPR Source: Colson Services & FTN Financial 16

18 Outlook Under the New Rule The SBA market is bifurcated Seasoned pools will likely continue to prepay at elevated levels New issuance largely not affected Risk averse investors will focus on new issuance or low to no premium pools Opportunities currently exist in the seasoned pool market for the right investor 17

19 Historical Prepayment Performance

20 What is at Risk? Since P&I is guaranteed, the primary risk is the return of principal dollars earlier than anticipated (prepayment/premium risk) As loans pay off, principal is returned to investor Premium associated with those principal dollars must be amortized Sources of prepayment can be voluntary (refinance) or involuntary (default) 19

21 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Default as a % of Total SBA Payoffs SBA 7(a) Loan Level Defaults Defaults as a Percentage of Total SBA Loan Payoffs near all time lows! 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Max: 80.8% Avg: 23.9% Min: 6.7% Last: 13.8% Default Average 6 Mth Mov. Avg. Source: SBA & FTN Financial 20

22 3 Mo. CPR SBA 7(a) 3 Month Speeds 3 Month CPRs for two major WAM buckets Jan /15/ Oct Rule Change Yr SBA Pool 3 Mo CPRs SBA 21+ Year Pools Source: Colson Services & FTN Financial 21

23 3 Mo. CPR 62 Historical Comparison to Residential MBS 3 Month CPR Speeds: 8-11 & 21+ Year WAM SBA 7(a) Pools vs. Residential Mortgage Backed Securities SBAs exhibit a fraction of the prepay volatility of MBS Resi MBS 32 SBA Securities Yr SBA Pool 3 Mo CPRs SBA 21+ Year Pools 15 Year Conventional MBS 30 Yr Conventional MBS Source: FTN Financial & CPRCDR 22

24 Prepayment Drivers Health of Economy Modeled by Unemployment Rate Shape of the Yield Curve flatter = faster / steeper = slower Age of the pool Prepays follow a pretty reliable aging curve Apex at 24 mos. for Equipment/Working Cap. Pools Apex at 36 mos. for Long Real Estate Pools 23

25 Managing Prepayment Risk Line item diversification is key Low loan counts relative to MBS Goal is to reach a level of diversification in the portfolio where prepay results mirror the aggregates Our studies indicate that position in individual pools is optimal 24

26 Relative Value

27 Yield Relative Value: Yield/Duration Landscape Landscape of investment options across the yield curve YR/1YR 10YR MBS 5YR BULLET YR/1YR TXBL MUNI YR BULLET CP - 60 Day CP - 30 Day CP - 90 Day CP - 7 Day CP Day CP Day SBA FLT (106) SBA FLT (Par) CP - 14 Day CP Day State Prime Pool State Gov Pool CP - 1 Day Effective Duration Source: Bloomberg & FTN Financial (Pricing as of 3/9/2018) 26

28 Yield Relative Value: Yield/Duration Landscape Short end of the investment landscape CP Day CP Day CP Day State Gov Pool State Prime Pool SBA FLT (Par) CP - 30 Day CP - 14 Day CP - 90 Day CP - 60 Day SBA FLT (106) CP - 7 Day 1.25 CP - 1 Day (0.50) (0.30) (0.10) Effective Duration Source: Bloomberg & FTN Financial (Pricing as of 3/9/2018) 27

29 Conclusion & 2018 Outlook Yield pickup over similar short term instruments Primary risk is prepayment/premium risk Expect continued growth in pool issuance 10-15% growth per year... $10B+ in 2018? Market will remain bifurcated as the Agency transitions away from the old excess principal rules Speeds Expect reversion to long-term program averages ~12CPR 28

30 Disclaimer This material was produced by an FTN Financial Strategist and is not considered research and is not a product of any research department. Strategists may provide information to investors as well as to FTN Financial's trading desk. The trading desk may trade as principal in the products discussed in this material. Strategists may have consulted with the trading desk while preparing this material and the trading desk may have accumulated positions in the securities or related derivatives products that are the subject of this material. Strategists receive compensation which may be based in part on the quality of their analysis, FTN Financial revenues, trading revenues, and competitive factors. Although this information has been obtained from sources which we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. This is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results, while changes in any assumptions may have a material effect on projected results. Ratings on all securities are subject to change. FTN Financial Group, FTN Financial Capital Markets, FTN Financial Portfolio Advisors and FTN Financial Municipal Advisors are divisions of First Tennessee Bank National Association (FTB). FTN Financial Securities Corp (FTSC), FTN Financial Main Street Advisors, LLC, and FTN Financial Capital Assets Corporation are wholly owned subsidiaries of FTB. FTSC is a member of FINRA and SIPC FTN Financial Municipal Advisors is a registered municipal advisor. FTN Financial Portfolio Advisors is a portfolio manager operating under the trust powers of FTB. FTN Financial Main Street Advisors, LLC is a registered investment advisor. None of the other FTN entities including, FTN Financial Group, FTN Financial Capital Markets, FTN Financial Securities Corp or FTN Financial Capital Assets Corporation are acting as your advisor and none owe a fiduciary duty under the securities laws to you, any municipal entity, or any obligated person with respect to, among other things, the information and material contained in this communication. Instead, these FTN entities are acting for their own interests. You should discuss any information or material contained in this communication with any and all internal or external advisors and experts that you deem appropriate before acting on this information or material. FTN Financial Group, through FTB or its affiliates, offers investment products and services. Investment Products are not FDIC insured, have no bank guarantee and may lose value. 29