in partnership with Ben Clark, FHN Financial and Matt Saslawsky, Windsor Advantage GGL Sales Associate
In this report: key themes of SBA secondary market performance in 2023, factors shaping the outlook for 2024, and the ripple effect of recent SOP changes that lenders should watch.
I. Overview of 2023 SBA Loan Secondary Market Performance:
SBA Premium Pricing Data from Windsor Advantage’s Loan Servicing Desk with Commentary by Matt Saslawsky, GGL Sales Associate.
Premium prices stagnated in 2023 as sales activity slowed, maintaining the below-average premium prices recorded in 2022. It was a stark contrast when compared to the record-high performances of prior years (2019-2021), however, to be expected based on a few key shifts in the SBA landscape. Including:
- Depository Institutions’ Need for Liquidity
- Higher Prepayment Rates and Borrower Defaults
Below are SBA Premium Price Highs and Lows for the 2023 FY:
SBA Secondary Market Premiums by Quarter
10 Year Premiums peaked in the first quarter of 2023 at 112.999. Throughout the year prices dropped marginally, in stark contrast to the volatility observed in previous years (namely, 2020 and 2021).
*Windsor did not bid any 25Y term loans for Q4.
While the performance was relatively stable for 10 year loans, we did find that bids were lower all around for both 10 and 25 year notes. The lower bids are an indication of less interest than in past years.
This is due to: 1) faster prepayments speeds, 2) less demand for the product against its non-government backed loan peers and 3) a softer yield curve.
In 2023, we sold significantly less 25 year loans than average which is a direct relation to our Clients having less interest in “commercial real estate” backed SBA 7(a) credits for construction or commercial real estate projects. We also feel this lack of interest in CRE as of late is due to a highly saturated market in that field. We expect competition to increase as we lean into 2024 and applicants reacclimate to this rate environment.
II. Factors Impacting Secondary Market for SBA Premiums in 2023
An Interview with Ben Clark, FHN Financial: insight on the factors that shaped 2023 SBA secondary market performance and the outlook for 2024.
This year’s pricing data reflects a few shifts in the secondary market for SBA loans.
After seeing such a successful year of loan sales in 2022, it was difficult to not have high expectations for 2023. However, 2023’s rising interest rates tightened the credit hold on borrowers throughout the year, and initial demand for the SBA product suffered. This carried over to the secondary market, resulting in fewer premiums being offered for loans on the secondary market and the lower pricing outlined above.
The 2023 Secondary Market for SBA loans was shaped by a few key factors. In similar fashion to last year’s performance, there continues to be an off-balanced tension between supply and demand for SBA premiums compared to years prior.
Depository Institutions Less Involved in Buying Premium Pools
Demand for SBA premiums from depository institutions was tampered significantly by the 2023 interest rate environment and challenging banking conditions this year.
Ben Clark of FHN Financial, explains how and why this shaped the performance of SBA premiums on the secondary market:
“Historically, the largest buyers of SBA 7(a) securities have been banks and credit unions. These institutions reported continued pressures on deposits coupled with mounting losses (realized or not) in their bond portfolios as a result of rising rates. For these reasons, depositories have been largely focused on increasing liquidity throughout the year and have not been reinvesting roll-off in the bond portfolio.
We saw some selling activity in the 4th quarter – even at significant losses in some cases. However, the proceeds were mostly used to pay down costly brokered deposits or other borrowings, shrinking the balance sheet to strengthen capital ratios or building liquidity positions. The purchase activity observed throughout last year was inconsistent and almost entirely focused on lower dollar price and PAR-priced SBA pools.
However, as we all know, nearly all SBA 7(a) loans trade at a premium to PAR. Therefore, in order to create pools to meet current investor demand, dealers must strip the coupons down significantly. The bi-product of this are interest-only strips which have always been the most inefficient and least liquid component of the SBA pooling process. We don’t expect that dynamic to change until depository institutions return to the SBA pool market in full force and start buying premium pools again.”
Prepayment Rates
With the year’s interest rate hikes, it comes as no surprise that we observed a spike in prepayment speeds. And consequently, lower premium prices.
According to Clark, “When short-term rates are rising faster than long-term rates (what the market calls a “bear-flattener”) there is an increased incentive for 7(a) borrowers to seek out refinancing opportunities in the conventional commercial loan market. This is because their SBA borrowing costs are adjusting and pegged to the short-end of the curve while most conventional commercial loans are pegged to the 5yr or 10yr tenor of the curve.
We’ve seen a steady increase in prepayment rates over the last 12-18 months as a result. Defaults had been pretty much non-existent until July of this year. Since then, they have been on a steady incline and are now well above the long-term program averages.
In fact, more than 1 in 4 early prepayments in the SBA 7(a) loan portfolio are currently attributable to default.
In summary, 7(a) pool investors are getting hit from both sides of the prepayment spectrum – voluntary and involuntary. This will continue to be a dampener on secondary market loan pricing into 2024.”
SBA Debt Refinancing Rules Redefined by SBA SOP
New rules for SBA debt refinancing set by the latest SBA SOP may be part of the pressure driving down premium prices. The latest guidance according to the 2023 SBA SOP:
“A Lender may refinance an existing non-SBA-guaranteed loan or Borrower debt from another lender if the new loan meets the SBA 10 percent improvement to installment payment amount requirement in paragraph d. below: however, the new 7(a) loan is not subject to SBA’s 10 percent improvement to installment payment amount if the debt to be refinanced is a revolving line of credit.” SOP 50 10 7.1 pg. 94-95
Clark expresses concern that this could further challenge the SBA secondary market: “There is tremendous concern among investors about the potential incentive that this creates for lenders to refinance their own or another lender’s SBA loans for the sole purpose of generating more fee income from loan sales. While the magnitude is unknown at this point, this change will undoubtedly add to the already elevated prepayment environment and contribute to the downward pressures on premiums in the secondary market.”
III. Adapting to the 2024 SBA Secondary Market
Insights from Matt Saslawsky, Windsor Advantage GGL Sales Associate, and best practices for SBA Secondary Market Strategy from the Windsor Advantage team.
Potential Market Corrections
After experiencing one of the toughest financial years since 2008, there are many positive outlooks that we can maintain in 2024. Last year’s extreme rate hikes put a chokehold on most borrowers. Many borrowers have found themselves paying significantly more interest than expected and oftentimes paying more than principal every month on their loans, further adding to their financial difficulties.
Relief should be in sight, ushered in by the economy’s unexpectedly soft landing. FOMC recently decided to hold interest rates steady yet again. An additional 3+ rate cuts are projected for the remainder of 2024. It can be assumed that small business confidence in the economy will improve as threats of a recession dissipate, and steady interest rates loosen the grip on business liquidity. Increased confidence implies increased business and consumer spending, slower prepayment speeds, revisited business growth plans, and a higher risk tolerance for re-investing back into one’s business. This behavior could translate very well into a new wave of SBA borrowing, and consequently, a more active secondary market.
Ultimately, lenders should apply short-term strategies to cope with current challenges but keep a long-term mindset as you build your strategy for the secondary market.
Lender-controlled Factors to Consider
While lenders cannot fix the overarching factors weakening demand in the secondary market, they can adjust their strategy to accommodate expected market corrections. Patience will be crucial. You may also want to reconsider current Sell/Hold Strategies as a short-term solution to tide over your institution for the long run.
If you choose to hold, make sure you discuss with someone who can anticipate how the market will react to those maturities compared to shorter ones. It may influence your strategy on maximizing the cost-benefit of SBA lending as a fee income driver at your institution.
The following lender-controlled factors should be considered when structuring loans and estimating potential premiums:
- Time – 10-year loans should be bid to the secondary market immediately upon full disbursement and at a maximum, within thirty (30) days of funding in order to garner the highest secondary market premium. 25-Year loans should be bid within the first ninety (90) days.
- 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 – Lenders should expect that every $500,000 of a guaranteed portion above $1,000,000, premium will drop by roughly a quarter point (0.25%).
About Windsor Advantage
With more than 150 years of cumulative in-house SBA 7(a) and USDA experience, cutting-edge systems, and rigid controls, the team at Windsor Advantage is uniquely qualified to support its institutional clients to develop and execute a thoughtful and comprehensive SBA and USDA lending program.
Windsor Advantage is an owner-managed lender service provider with 50 professionals and growing. Contact our team.