SBA 504 Capital Markets and Funding Process. Steve Van Order Fiscal Agent August 2002

Transcription

1 SBA 504 Capital Markets and Funding Process Steve Van Order Fiscal Agent August 2002

2 Table of Contents 1. SBA 504 Capital Markets and Funding Process 2. Note Rates and Effective Rates 2

3 SBA 504 Capital Markets and Funding Process 3

4 A Very Successful Program Sections 503 (1958), 504 and 505 (1986) of the Small Business Investment Act provide for guarantee and pooling of CDC-issued debentures and guarantee and issuance of Development Company Participation Certificates (DCPCs). Provides monthly access to public capital markets otherwise unavailable for small businesses. Uses a proven securitization process to create appealing investments resulting in efficiently-priced, low debenture rates. 16 years of history have led to stable performance through multiple interest rate and economic cycles and crises. $15 billion of certificates have been issued. 4

5 From Borrowers to Investors: The Process Issuer and Trustee (The Bank of New York) Debentures Certificates Underwriters (Merrill Lynch, CSFB) Funds Certificates Investors Debentures Funds Guarantee on Certificates Fiscal Agent (DCFC) Funds Central Servicing Agent (Colson Services Co.) Debentures Loan Proceeds SBA Loan Approval & Guarantee Guarantee on Debentures Certified Development Companies Notes Small Business Borrowers Source: Merrill Lynch Research,

6 Capital Markets Team Fiscal Agent Development Company Funding Corp. Manage the funding process to obtain the best monthly debenture rate available for borrowers. Much of the work is contracted to an experienced financial adviser (currently VOIS, Inc.). Underwriters Merrill Lynch and CSFB. Market, sell and trade DCPCs, take capital risk, support the market, do product research. Issuing Agent and Trustee The Bank of New York. Hold debentures issued by CDCs, issue DCPCs as SBA s agent, distribute P&I to DCPC holders, report outstanding pool statistics. Central Servicing Agent Colson Services Corp. Process loans, report new pool statistics to DCFC, collect loan payments, pay out proceeds. Legal Counsel McKee Nelson, LLP. Program and transaction legal advisors to underwriters and DCFC. Clearing agent Depository Trust Company. 6

7 Complexity of a Deal Legal/tax status. Debenture P&I payments guaranteed under section 503 of the 1958 SBA act. DCPCs are government securities authorized under section 505 of the SBA act. Each pool is a grantor trust with holders owning a pro rata interest. Underwriting arrangements: 7 documents, including offering circular, legal surveys, approvals. Execution Documents: 5 documents, including debenture pooling, purchase and exchange and delivery. Closing documents: 14 documents, including various certificates, opinion letters and proceeds disbursement instructions. 7

8 Multiple Interest Rate Cycles SBA Year Debenture Rate (%, left scale) and Amount Issued (rolling 12 month total, $MM, right scale) ,800 1,600 1,400 1,200 1, Rate Issued 8

9 Debenture and Note Features Feature Interest rate Payment date Amortization Prepayment Prepay penalty Debenture Debenture rate Semi-annual Semi-annual Semi-annual Scheduled Note Note rate Monthly Monthly Semi-annual Scheduled 9

10 Why Do the Features Differ? Debenture semi-annual payment was chosen to appeal to government and corporate bond investors who expect semiannual payments. Borrowers make monthly payments. Semi-annual prepayment restriction and prepayment penalty result in a much lower interest rate for small business borrowers. An option to prepay at anytime with no penalty would cost well over another point on the debenture/note rates. Historically, under half of borrowers have prepaid. All borrowers should not pay a higher rate so some can prepay. Rich historical data appeal to investors. 504 program boasts 16 years of data. This is a selling point and keeps rates lower. 10

11 How is the Debenture Rate Determined? Pre-Marketing. A week prior to pricing, fiscal agent and underwriters agree on a spread range over interest rate swaps and underwriters attempt to sell the deal within this range. Marketing. Depending on the reception to the deal, pricing will occur somewhere within the range, or, if the range is not sufficient to sell the deal, a new range is determined and the deal re-marketed. 11

12 How is the Debenture Rate Determined? (cont'd) Pricing. Fiscal agent and underwriters agree on the bid-side yield of the appropriate treasury benchmark, the mid-market interest rate swap spread, and the spread to swap. The fiscal agent accepts the rate and obtains approvals from Treasury and SBA. Debenture Rate. The debenture rate = treasury benchmark yield + swap spread + spread to swap. 12

13 Priced Against Swaps and Treasuries SBA 20-Year 504 Debenture Rate versus 10-Year Treasury Yield (%) sources: DCFC, Bank of NY, Federal Reserve

14 ... as well as Other Benchmarks SBA Year Debenture Spread (in BP) vs. 10-Year Benchmarks Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01 Jan-02 Mar-02 May-02 UST SWP DUS CMBS 14

15 Who Buys 504 PCs? Insurance companies yield, safety. U.S. banks yield, government security status. Mutual funds yield, spread, price appreciation. Yankee banks spread to LIBOR, often swapped to duration match. 15

16 What Do Investors Like About 504 PCs? Full faith and credit of the U.S. Absolute yield. Spread over other government bonds due to prepayment option. Long history, rich prepay/acceleration data. Regular offering calendar. Decent pool size, secondary market exists. 16

17 Note Rates and Effective Rates 17

18 What is the Note Rate? Note rate: The interest rate required to equate the semiannual debenture P&I schedule with a monthly schedule. Simple concept but complex calculation required. Typically has been about 8 BP above debenture rate. Derivation: The semiannual P&I payment amount is divided by 6 to obtain a monthly payment. This is broken down into (a) monthly amortized principal schedule (where UBP = 0 after last payment) and (b) interest. Note rate obtained via an iterative calculation (e.g., the solver function in Excel or HP12c). 18

19 Converting Debenture Rate to Note Rate (using HP12c calculator) Assume 5.80% rate, $350,000 orig. prin., 20-yr. Inputs n = 40, i = 2.9 (rate / 2), PV = Solve for PMT which = Clear registers using {f} {FIN} and {f} {REG}. Inputs n = 240, PV = , PMT = [ / 6] converts semi-annual payment to monthly. Solve for i which = Annualized rate = % x 12 = 5.878%, within point of reported rate for 6/02. 19

20 What are Effective Rates? Periodic annual interest rates derived by calculating the impact of amortized fees (CDC, SBA, CSA). Do not include the impact of upfront fees, therefore, are not strictly speaking APRs points is worth about 35 BP at today s rates over 20 years. Effective rate for any period n = (interest+cdc+sba+csa) / base UPB x Where base UPB = opening UPB for each new calculation period (i.e., mos. 1, 61, 121, 181). Monthly annualized effective rates are averaged (weighted by balance) over 60, 120, 180 and 240 months and reported by Colson and posted on the NADCO web site. 20

21 Effective Rates: Example 5.80% deb., 5.88% note rates, 20-yr. term, 0.625% CDC, 0.41% SBA, 0.10% CSA Pmt.# UPB Interest CDC SBA CSA Eff. % 1 350,000 1, ,047 1, ,023 1, ,865 1, ,493 1, , , ,

22 Effective Rate Behavior Over Time 70.0% 14.0% 40.0% 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0%

23 Why Effective Rates Rise Over Time Principal Amortization vs. (Terraced Fees x 1000) $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $ UPB Fees x 1000 Linear (Fees x 1000)

24 How Can You Estimate Effective Rates? There is no generic calculator available. The best solution is to go back about six months and look at the range of spreads between effective rates (with the appropriate combination of fees) and the debenture rates. Look at the average, high and low spreads and develop a rule of thumb spread. Add this spread to your estimated debenture rate. Review your estimate every few months. 24

25 disclaimer The information herein has been obtained from sources that we believe to be reliable, but we do not guarantee its accuracy or completeness. Development Company Funding Corporation, All rights reserved. This presentation may be downloaded from the NADCO website: 25