“What if?” How many times and how many ways has someone started a conversation like this with a
Borrower: What if you hold the title on my ’83 Camaro as additional collateral?
Examiner: What if Fannie Mae and Freddie Mac walk from their debt obligations?
Depositor: What if you pay me an extra five basis points on my $5,000 CD?
Auditor: What if your Held-to-Maturity bonds go further underwater?
Lender: What if we put a 6% cap on this floater?
Investor: What if you bought my 25 shares at three times book?
What if you could purchase a full faith and credit instrument that pays monthly principal and interest,
adjusts based on prime with no caps, has little or no prepayment risk, and out-yields the 10-year
All of the above qualities currently exist in a Small Business Administration (SBA) 7(a) loan pool.
These have long been the choice of investors looking for additional yield on the very shortest end of the
maturity spectrum. Most 7(a) pools adjust with the calendar quarter, although there are some monthly
adjusters available. It is true that there are no rate caps, either periodic or lifetime. All these factors make SBA securities the most rate-sensitive of any in the market.
There has been a lucrative two-way market for SBA pools for at least 30 years. Community bank lenders
like the ability to make loans to qualifying borrowers that don’t quite fit the standard parameters. They
also like the ability to sell the guaranteed portions of the loans (usually 75%) and retain the servicing
and the relationship. And they especially like selling them at big premiums. By the end of 2018, the
balance on outstanding 7(a) pools was over $32 billion, which was a high water mark for the agency.
Nine out of 10 loans originated are sold in the secondary market to a consortium of SBA poolers.
Response to demand
To a community bank investor, the rub with the pools has historically been the high purchase prices. All
of the characteristics, except for the premiums attached, are prized by risk-averse portfolio managers.
While there are ways to manage those prepayment exposures, there’s no getting around the fact that an instrument that costs 110 cents on the dollar or more, and can prepay at the borrower’s behest, contains risk.
In response, there are now SBA securities being issued and available at prices very near par. As part of
the pooling process, certain amounts of the loan rates can be stripped off for alternative uses, leaving
just enough coupon pass-through on a given bond to result in a market price between, say, 99.50 and
Yield and price stability
You may have heard that the yield curve is relatively flat. In the good news/bad news environment in
which community banks invest, this is a concrete example. The positive is that short-term bonds yield
about the same as longer-term bonds, so today you don’t have to extend your maturities for reasonable returns. The negative is that a flat curve is usually followed by a secular drop in rates, more so on the short end. True floaters, like SBA 7(a)’s, will be the first to see their yields fall.
More to the point, it’s totally uncertain that any rate-cutting will happen in the near future. Macro
indicators like GDP, employment and inflation aren’t pointing to recessions any time soon. And just as
the current level of fed funds is far below the normal stop-out point in a rate hike cycle, maybe we’re in
for a protracted period of stable rates.
If so, then the current yields on these 7(a) pools are quite handsome. It’s not too difficult to achieve a
return of around prime minus 275 basis points (2.75%), which as of this writing equates into a true yield
of about 2.75%. Where’s the value in that?
For starters, the 10-year Treasury note has averaged about 2.65% this year. For closers, these par-level
bonds have virtually no prepayment risk and very little price risk, are pledgable, and produce monthly
What if you committed a portion of your securities portfolio to investing in low premium SBA 7(a)
Jim Reber is president and CEO of ICBA Securities and can be reached at (800) 422-6442 or