Independent Banker - July 2023 - 35

Next: Fighting the SVB failure's impact on community banks 
are direct obligations of Uncle Sam,
and new issue volumes continue to set
records, so the SBA market continues to
broaden and deepen. Two of the more
visible products are 7(a) pools, which
are true floating rate instruments, and
Development Company Participation
Certificates (DCPCs), which are fixed
rate pools with long average lives.
It makes logistical sense to consider
them together for a barbell. For one
thing, credit quality is unsurpassed. For
another, one would be hard-pressed
to find two bonds with more disparate
price-risk profiles. For still another,
we can address premium risk that
attaches to the 7(a)s by pairing them
with a DCPC that is available at a price
near par. Finally, at this point in the
rate cycle, both ends of the barbell yield
much more than they would have a
year ago, so an investor today has a big
head start over 2022.
End of cycle projections
We created a hypothetical barbell
portfolio by modeling equal amounts
of 7(a)s and 25-year DCPCs. For the
record, the actual pools are SBA 540099
at a purchase price of 108.875, and
SBAP 2023-25 D 1 at 100.00. We made
note of their market values and yields
At this point in the rate cycle, both ends
of the barbell yield much more than they
would have a year ago, so an investor
today has a big head start over 2022.
as of April 30, 2023, and in a 100-basis
point (1.00%) lower environment over
the next year. This rate-cut assumption
was driven by both the fed funds futures
market and by the Fed's most recent
projections. (At the present, marketdriven
expectations are calling for about
five 25-basis point cuts over 12 months,
while the Fed is estimating about two.)
Here are the more important average
weights and measures:
Current
Yield
Effective
duration
Market
value
Education on Tap
Quarterly economic
webcast in July
Dr. Lindsey Piegza, chief
economist for ICBA Securities'
exclusive broker Stifel, hosts
her quarterly Economic Insight
Live webcast on July 13 at 1
p.m. Eastern. To register, visit
icbasecurities.com
Two variables could make these
projections either better or worse than
actual. One is that we are assuming a
parallel shift downward in the yield
curve. What's more likely to happen
is steepening, by virtue of short
rates reacting more in step with Fed
easing, and longer rates moving less in
comparison; that would mean the fixed
rate pool wouldn't appreciate in price
as much. The other is that DCPC's carry
a penalty for " voluntary conversions "
5.26%
Mid-2024
4.76%
3.16 years 3.10 years
104.44
107.40
(refinancings, for example) for 10 years
that is passed through to the investor.
Since we can't assume any penalties will
actually be paid, we ignore them for this
projection, although the yield could be
enhanced by prepayments. As it is, most
of the barbell's yield will be maintained,
while the duration remains unchanged,
and the positions have about a 3%
unrealized gain. That's a success.
Stretch before you lift
As always, a word of advice from your
trainer. These securities will probably
produce very little cash flow in the
early stages, especially if the pools are
new. As they season, it's more likely the
floaters will have faster prepayments, so
you'll need to monitor your positions to
keep the fixed/floating balance in place.
So, if your bond portfolio is suffering
from a lack of recent energy or isn't
built to run into the headwinds from
the Fed's monetary policy, take a trip to
your favorite broker's financial fitness
center. A session in barbell lifting
can help flex your community bank's
economic muscle.
Jim Reber, CPA, CFA (jreber@
icbasecurities.com), is president
and CEO of ICBA Securities, ICBA's
institutional, fixed-income brokerdealer
for community banks
independentbanker.org // 35
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Independent Banker - July 2023

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