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504 Interest Rates Remain Low … But for How Long?

Aug 2011

The 20-year interest rate on Small Business Administration (SBA) 504 commercial real estate loans dropped in August to 5.14% - the lowest rate for the loan program this year.

So far in 2011, 504 rates have been under 6% for all months but February and have been slowly declining toward the mid to low 5% mark to date. Last year saw several 504 rate records set at under 5%, with the lowest 20-year rate ever recorded at 4.52% in October 2010.

For small business owners looking to purchase or renovate their existing properties, this has been welcomed news. Unfortunately, the recent unwelcomed news of the federal debt ceiling crisis and resulting volatility in the financial markets could impact 504 interest rates going forward.

Where Will 504 Rates Go From Here?

To begin, 504 loans are funded by the sale of debentures (or bonds) which are pooled and sold on Wall Street each month. The effective rate is comprised of the debenture rate (which is pegged to an increment above the current market rate for U.S. Treasury issues), the note rate and ongoing carrying costs of the program as set by the SBA.

While the final effective rate calculation is technical, the entire process begins with the debenture rate. The entity responsible for selling 504 funding securities is the Development Company Finance LLC (DCFLLC) and its fiscal agent, Steve Van Order.

So where will 504 rates go from here? According to Van Order, we may see more persistent month-over-month volatility in the 504 debenture rate, both higher and lower. He explains in the following excerpt regarding the August debenture offering:

“The August debenture offering was conducted during some of the most volatile financial market conditions in recent years. Before the deal was announced U.S. leaders agreed and passed legislation raising the debt ceiling. So the specter of a delayed offering while Treasury ran out of cash vanished. Be sure, however, that during the prior week SBA's fiscal and selling agent, DCFLLC, pulled its contingency plans off the shelf and held discussions on how to manage in a scenario without a debt ceiling increase. But, fortunately, those plans went back on the shelf. What could possibly be next after that near miss?

“Well, after the debt ceiling problem we then encountered severe global financial markets selloffs around the globe. This was triggered by wholesale dumping of the bank stocks and debt of Italy and Spain which started panic like selling of riskier assets in global markets. After a false start that actually made things worse, the European Central Bank stepped in to stabilize the euro area government debt market. But markets remained very volatile and stocks tended to plunge. We announced the debenture offering on schedule.

“Then, last Friday morning (Aug. 5) the rumor circulated in the bond market that S&P would finally get around to the U.S. rating cut it warned of in July. The action came that Friday night. Credit markets were very well-prepared for the S&P action. Over the weekend federal regulators, the Fed and the key clearing house corporations announced no change in the treatment of U.S. government-guaranteed securities for investment or loan collateral purposes. Domestic investors had already reviewed their guidelines and determined if what if any action was required. Foreign central banks, major owners of treasuries, reiterated commitments to keep investing in them.

“The government-guaranteed debt markets have operated smoothly and efficiently during the recent turmoil. Treasury yields fell sharply in reaction to a dimmed outlook for economic growth and broad market turmoil. A global flight to safety (i.e. liquidity) occurred and treasuries, with over $9 trillion publicly available and the deepest market in the world, were the destination of the flight.

“That broad market turmoil did require a wider requited spread to pricing benchmarks in the August debenture offering. During a flight to liquidity in tumultuous markets spreads of all other market sectors will widen to treasuries and government-guaranteed agency obligations, including the SBA's, are no exception. Spreads on mortgage-backed securities such as the SBA's are also adversely affected by falling treasury yields, flattening yield curve and higher interest rate option price volatility - all measurements that moved quite sharply over the last few weeks.

“Borrowers, however, benefited from the very sharp drop in benchmark 10-year treasury yield and interest rate swap rate. The 3.29% debenture interest rate was the fourth lowest on record. Only the December 2009 and the pre-QE2 rally-related rates in September and October 2010 were lower.

“Looking ahead, all we can reasonably predict is the potential for acute and perhaps persistently higher volatility. Program participants should remain prepared for material month-over-month (higher or lower) changes in the debenture interest rate.”

For more information about 504 loans in Florida, contact Florida First Capital by visitingwww.ffcfc.com, emailing atinsider@ffcfc.comor calling 888.320.5504.