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MBS

September, 2019

SBA Jewels and Pools

SBA Jewels and Pools is written by SBA veteran, Joel Banes

What drives the SBA market? Obviously, it’s the investors who pay the most for the product. It is crystal clear that the largest buyers of SBA loans have consistently been forming par pools. This means that the poolers are creating interest-only investments known as Certificate of Originator Fees “COOFs.”


What is so attractive about these COOFs? Let’s consider the economics of investing in COOFs.

Example

The current bid price is 116.73 for a 25-year full coupon loan with a pass-through rate of Prime +1.075%.


In order to create par pool with a coupon of Prime Rate -2.60% (2.65% coupon based on 5.25% Prime Rate as of 8-1-19), it takes a 4.7 strip ratio.


The COOFs’ bond equivalent yield (BEY) using a 4.7 strip ratio at various Constant Prepayment Rates (CPR) are:

  CPR        BEY              Average Life        Treasury Yield        Spread

                                               (years)                       (8/16/19)

  12%        5.93%                6.54                         1.50%                         +443

  13%        4.81%                6.16                         1.48%                         +333

  14%        3.68%                5.81                         1.47%                         +221

  15%        2.55%                5.49                         1.43%                         +112

  16%        1.40%                5.19                         1.43%                             -3


Keep in mind that strips come from pooled loans, and as such, have the same prepayment speed as the underlying par pool.

At what prepayment speed would a sophisticated investor take 100% prepayment and default risk?


In this example, the COOF investor would pick up 333 basis points at a 13% CPR and 443 points @ a 12% CPR. Given the July vectored CPR for a new 25-year pool of 12.4% (21yr+ WAM) one appears to be well compensated for taking on the prepayment risk. However, the treasury yields were approximately 100 basis points higher until recently.

These full-coupon 25-year loans were trading at an approximate price of 116.375 in the middle of April. The appropriate strip ratio would have been 4.6.

  CPR        BEY              Average Life        Treasury Yield        Spread

                                               (years)                       (8/16/19)

  12%        6.41%                6.54                         2.46%                         +395

  13%        5.25%                6.16                         2.42%                         +283

  14%        4.09%                5.81                         2.41%                         +168

  15%        2.92%                5.49                         2.40%                            +52

  16%        1.74%                5.19                         2.38%                             -64


On April 15th, the spreads at 12% and 13% CPRs were 395 and 283 basis points respectively. However, if one used a 14% CPR the pickup in yield was only 168 basis points, at 15% a mere 52 basis points, and at 16% an investor would lose 64 basis points. 

Given that the market has held up at these prices, it is apparent that COOF investors are betting on prepayment speeds staying under a 13% vectored CPR. At higher speeds, these investors simply aren’t compensated for taking on the risk.


The converse should be true as well. Investors looking at new premium pools with a 21yr+ WAM want to be sure that they are being properly compensated for premium risk based on the latest vectored CPR. The current vectored speed for August is 12.5% based on Bloomberg SBA prepayment speeds (PSBA).


Please contact your Hanover representative for more information.

Joel Banes is a seasoned SBA professional in Memphis, Tennessee with over 25 years of industry experience specializing in the management of fixed income securities, specializing in the SBA 7(a) and USDA market. He is the Founder and CEO of Banes Capital Management, LLC, and served as Managing Director of SBA Pooling and Trading for Shay Financial Services, Inc. for a decade. He launched broker-dealer Hanover Securities in 2016 with long-time friend and business associate, John Hanover of Los Angeles. He trades SBA, USDA and FSA loans, SBA 7a pools, SBA COOFs as well as MBS's and other traditional fixed income products. Joel has a B.S. from the University of Tennessee and studied at the Wharton School of Finance, University of Pennsylvania.

Although this information was derived from sources which we believe 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. Securities which may be shown are subject to prior sale and change in price. Past performance is not indicative of future results. Changes in assumptions may have a material effect on projected results. Hanover Securities is a member of FINRA and SIPC.

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