Barring any unforeseen market events, 2019 should continue to be a year of slow, positive growth for SBA 7(a) loan secondary market premiums. Last year, we experienced some of the steepest declines in secondary market premiums in years, with 10-year, fully priced SBA 7(a) premiums swinging nearly 340 basis points between FY Q2 and Q4.
While there are several factors that can be attributed to this activity, the most impactful was the dramatic increase in prepayment speeds towards the last few months of 2018. Constant Prepayment Rate (CPR) is the measure of loan prepayments as a percentage of outstanding loan balance and is a key indicator for tracking the performance of SBA 7(a) pools. In October of 2018, prepayment speeds (CPR) reached nearly 20% – the highest level in years. To put this into perspective, CPR during the same quarter the prior year was nearly half this rate at 12.45%!
The market in 2019 has once again shifted and premiums are back on the upswing. Although the significant increase can’t be isolated to one-single variable, there are two concepts that have likely contributed to the recent upsurge:
- A strengthening economy
- A steady increase in WSJ Prime (“Base Rate’”) over a twenty-four-month period (i.e. Quantitative Tightening)
In our latest whitepaper, our team expands on each of these factors, but for the purpose of this article, let’s take a look at some of the recent highs and lows Windsor has seen in the market, and review lender-controlled factors every lender should consider when attempting to achieve the highest premiums available.
SBA 7(a) Premium Data
Loan premiums are not widely published which often makes it difficult for lenders to ensure they are receiving the highest secondary market premium for loans bid to the open market. To increase competitiveness, lenders should prepare bid sheets and submit the opportunity to no less than ten investors. Only through experience can lenders get a feel for the most active participants in the secondary market and understand what drives those participants to pay the highest premiums based on how the loan is structured.
Quality, guaranteed, variable rate asset demand will continue to bolster the 7(a) secondary markets, regardless of prepayment speeds. Based on a sample of more than $420 million in government guarantees sold through Windsor’s platform in FY 2018, the table below illustrates the up-tick in premiums from Q4 2018 lows.
Lender-controlled Factors to Consider
Several factors impact the level of secondary market premiums. Market forces such as supply-and-demand and interest rate changes cannot be controlled by lenders, but the following lender-controlled factors should be considered when structuring loans and estimating the overall return:
- Time — 10-year loans should be bid to the secondary market immediately upon full disbursement. 25-year loans should be bid within the first two months of full disbursement.
- Term — Longer terms receive higher premiums. 25-year terms result in a higher premium than 10-year terms.
- *Spread — Maximum spread over prime is 2.75% on loans over $50,000. Maximum spreads receive the highest premium.
- Adjust — Quarterly and monthly adjusts receive the highest premiums, versus annual adjust and fixed rate loans.
- Size — The size of the loan impacts the premium, with larger loans receiving less premium.
Q1 of 2019 has marked a gradual increase from last year’s 7(a) premium figures. In addition, the Fed has provided guidance indicating little to no rate hikes for the remainder of 2019. Theoretically, fewer rate increases translates to a lower number of Base Rate increases, thereby slowing prepayment speeds and increasing 7(a) premiums moving forward.
About Windsor Advantage, LLC
Windsor Advantage provides banks, credit unions and CDFIs with a comprehensive outsourced SBA 7(a) and USDA lending platform.
Since 2010, Windsor has processed more than $2.3 billion in government guaranteed loans and currently services a portfolio in excess of $1.3 billion (as of April 30, 2019) for over 85 lenders nationwide.
With more than 150 years of cumulative SBA and USDA lending experience, cutting edge technology, rigid controls and consistent processes, Windsor is uniquely qualified to assist any size lender with implementing a thoughtful and profitable government guaranteed lending initiative.
Windsor Advantage has offices in Chicago, Illinois; Indianapolis, Indiana; and Charleston, South Carolina.
About the Author: As President & CEO of Windsor, Mike is responsible for the overall management and direction of the firm, as well as oversight of the Charleston, Chicago and Indianapolis offices. Prior to Windsor, Mike was a senior management consultant with KPMG and began his career in rate derivatives for PNC Capital Markets.