SBA Pools
Q: Are SBA Pools carried on the books as loans or investments?
A: SBA pools are government guaranteed securities and are booked in the investment portfolio.
Q: What is the risk weighting of SBA pools?
A: SBA pools are 0% Risk Weighted Assets. SBA pools are unconditionally guaranteed as to timely principal and interest payments by the full faith and credit of the US Government. SBA pools carry the same credit quality as US Treasury Bonds.
Q: What are the primary reasons to invest in SBA pools?
A: Safety of principal dollars invested and protection against swings in the market value of the securities due to movements in interest rates are the primary reasons investors invest in SBA pools. The government guarantee ensures the return of principal dollars invested and accrued interest. The quarterly variable rate feature, without caps/floors, ensures an interest rate that is reflective of the current interest rate environment. This short effective duration substantially stabilizes the market value of SBA pools as compared to other fixed income investments.
Q: Are premiums paid for SBA pools guaranteed?
A: No. Principal and accrued interest is fully guaranteed, but premiums are not. As such, premiums are widely considered the primary risk exposure to SBA pool investors.
Q: Why do Investors pay premiums for SBA Pools?
A: SBA pools carry attractive (above market) coupons that command a premium when purchased in competition. Investors in premium priced pools consider the prevailing prepayment speeds in the market alongside earning an above market return to compensate for the premium paid. The higher coupon and longer maturity pools result in higher premiums paid. Typically, investors in premium pools look to increase returns by 75 to 150 basis points net after prepayment speed considerations over pools offered at par. Investors that do not wish to take premium risk will invest in lower coupon pools that trade at or near par. The fact that premiums have persisted since the first pools were issued in 1985 suggests that the asset class has historically performed well as contrasted against investor prepayment expectations. Please contact your representative for additional details on SBA prepayment data.
Q: Do SBA loans have prepayment penalties?
A: Yes. All SBA loans with original maturities of 15-years or longer have mandatory prepayment penalties of 5-3-1% (with a 25% annual exclusion). If, for example, the borrower was to pay off the loan during the first year, there would be a 5% penalty on the outstanding balance of the loan.
Q: Will I receive the prepayment penalty?
A: No. Penalties on SBA 7(a) loans are payable to the Small Business Administration.
Q: Are SBA Pools carried on the books as loans or investments?
A: SBA pools are government guaranteed securities and are booked in the investment portfolio.
Q: Are there any fixed rate SBA pools?
A: Yes. However, they represent about 1% of pools issued each year.
Q: Do the originating lenders take any risk?
A: Yes. The lender retains the unguaranteed balance of the loan which is typically 25% of the loan balance. Lenders may sell a participation in the unguaranteed balance with SBA’s approval. In most circumstances lenders maintain a minimum of 10% of the outstanding loan amount which is unguaranteed. Moreover, the lender only has a conditional guarantee on the guaranteed portion of the loan. The lender must follow the guidelines of the SBA program, including servicing the loan for its entire life, to keep the government guarantee intact. However, investors in SBA pools receive an unconditional Full Faith and Credit US government guarantee. This arrangement ensures that (a) the investor is not exposed to the lender’s servicing of the loan, and (b) that the lenders have an ongoing incentive to service the loans properly.
Q: Is a prospectus available for an SBA pool?
A: No. As with any government guaranteed security (including US Treasury Bonds), there are no prospectuses.
Q: How does an investor manage premium risk exposure?
A: Diversification is the most effective means of managing premium risk exposures. The greater the number of underlying loans, the lesser the effect of any one prepayment, and the more likely the portfolio prepayment experience will mirror the performance of the known universe of SBA loans. To see actual prepayment speed data for all SBA pools issued in the past 10 years, simply type in your Bloomberg terminal. If you’re not a professional Bloomberg subscriber, request a copy of the most recent report from your representative. Investing in newly originated SBA pools is equally as important as diversification because new issues with new loans have historically and consistently shown a pattern of very slow prepayments in the first year and ramp up as the loans age. Finally, ask your strategist for information regarding pooler prepayment speeds and related details aimed at minimizing and/or properly pricing prepayment risk.
Q: Can I get Community Reinvestment Act (CRA) investment credits for investing in SBAs?
A: Yes, provided the loans are in your CRA assessment area, and otherwise qualify for CRA. Since regulatory treatment can vary, please verify this with your regulators. Once you identify the loan(s) in the pool that you would like to purchase, you will purchase a pro-rata portion of the pool similar in size to the loan(s) balance.
Q: What is CECL, and how does it apply to SBA pools?
A: Current Expected Credit Loss (CECL) pertains to the Financial Accounting Standards Board (FASB) regulation which was fully implemented in January 2023. CECL methodologies are now employed and replace the previous method of loan loss reserves. The Full Faith and Credit government guarantee that SBA pools carry means that there is no CECL offset.
Q: What are delay days, and how do they affect my payment?
A: Delay days represent the point from the beginning of the accrual period of the underlying loans, following through as the monies go from borrower to lender, lender to Fiscal Transfer Agent (FTA) and, ultimately, to the investors. SBA pools have stated delay days of 84 and actual delay days of 54, with the difference due to SBA loans paying in arrears). The borrower payment due February 1st is remitted to the pool investor on March 25th. All SBA pools accrue on a 30/360 basis.
Q: What is the payment frequency on SBA pools?
A: Monthly principal and interest (P&I) payments are guaranteed on a timely basis by the full faith and credit of the United States Government. Monthly payments are automatically deposited into your DTC account on the 25th of the month.
USDA Pools
Q: How are USDA Guaranteed Loan portions treated on my books?
A: USDA Guaranteed Loan portions purchased in the secondary market are carried as loans for call reporting purposes.
Q: What is the credit quality and risk weighting of purchased USDA guaranteed portions?
A: USDA guaranteed portions purchased in the secondary market are unconditionally guaranteed as to principal and accrued interest by the full faith and credit of the US Government and are 20% Risk Weighted assets.
Q: Are the premiums I pay for the loans covered by the full faith and credit guarantee?
A: No. Premium dollars are not covered by the government guarantee and represent the primary risk exposure to investors.
Q: How do I receive payments on USDA loans that I purchase?
A: The originating/servicing lenders remit principal & interest payments directly to the secondary market holders via wire transfer. Loan buyers receive a document package on the settlement day, including 4 transfer documents, each with original signatures. The buyer keeps one transfer document for their files, returns one to the broker-dealer for their files, sends one to the USDA office listed on the Assignment Guarantee Agreement, and sends one to the lender along with wiring instructions.
Q: What denominations are typically available?
A: We normally utilize a one-time opportunity to break the loans into smaller denominations when the guaranteed portion is initially transferred into the secondary market. This typically allows investors to purchase denominations as small as $500,000 and enables them to build their portfolios with an eye to diversification.
Q: If my loan demand improves, can I resell the guaranteed portion back into the market?
A: Yes. USDA guaranteed loan portions are actively traded in the secondary market through a network of broker-dealers. Investors simply fill out a bid request form and submit it to the brokers they wish to get a bid from. It is suggested that sellers establish a bid deadline, and that they inform the winners shortly after the established deadline. Investors wishing to resell in the market are able to collect a number of competitive bids and confirm transactions with the winners on any given business day. Pricing is, of course, subject to market conditions.
Q: Are there CRA benefits associated with secondary market USDA guaranteed loans?
A: Assuming that the loan qualifies and that the borrower is in your institutions CRA assessment area, you may derive a CRA benefit for USDA loans that are purchased in the secondary market. Regulatory treatment may vary. Please check with your regulators for specifics
Q: Can a secondary market guarantee be denied for any reason?
A: Only if the investor has been involved in perpetuating a fraud with the lender. Otherwise, the guarantee is an incontestable full faith and credit guarantee of the US Government as to principal and accrued interest.
Q: What if a USDA loan that I have purchased becomes past due?
A: Contact the lender and inquire as to the past due status of the loan. You may also include your broker in the communications, as they may be able to offer some useful perspective and/or assistance.
Q: Should I agree to a Loan Modification Request from the originating lender?
A: Sometimes, when a borrower is struggling to service the debt, a modification of terms may be proposed to remedy the situation. The lender may, for example, request an interest only period for a time to assist the struggling borrower. Or, in some cases, a modification is requested to lower the interest rate to prevent the borrower from refinancing the loan with another institution. Don’t hesitate to contact your broker for assistance when considering such a request. The broker can tell you what the market value of the loan would be under the revised scenario to assist you in reaching a decision. If you determine that accepting the proposed change of terms would be preferable to the alternative scenario, please indicate your concurrence to the lender in writing.
Q: How do I collect on the guarantee if that becomes necessary?
A: If you have to collect on a guarantee, simply follow the procedures outlined in the Assignment Guarantee Agreement. The lender has the first right of refusal to repurchase the guaranteed portion at par, but few ever exercise that option. Instead, holders then file a demand with the USDA office listed on the Assignment Guarantee Agreement. The USDA office will then pay the investor all the outstanding principal and accrued interest that they are due.
