The following example illustrates the broker-dealer’s behaviour. Let us assume that when the price is e100, the broker-dealer receives a buy order for a hundred shares. The strategy he adopts is to supply half that amount from his own portfolio and buy the remaining fifty shares from the market at a price of e101 (supposing the price rises by 1 per cent with the buy order). At this price, the dealer resells all the shares ordered and the price goes back down to e100. The profit comes from selling at e101 the fifty shares he already had in his portfolio at e100.
We now tackle the issue of anonymity by extending the rational expectations model set out in previous articles to a regime of full transparency. Under those assumptions, participants observed only the market price and thus traded under the regime with anonymity. We now compare that case with a regime of full pre-trade transparency in which the identity of both informed and uninformed traders is disclosed and agents can consequently tell whether their counterparts are informed or uninformed.
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Expenses during the development, protection and marketing phases of inventing do not all occur at once. There is no need to have all the money that will be spent on the project at the beginning of the process. Very few independent inventors have a surplus amount of money set aside with which to pursue their product ideas. Most of us are operating on shoestring budgets. Many have succeeded and so can you. It may be necessary to save for a while and then move to the next phase of your product development. Then save again for the next phase and so on. As you read this book – or any book that details the steps in product development – you will see that there are lots of details related to your invention that you could be doing while you are saving between expenditures. So, it isn’t as if you have to spend all of your time in a holding pattern while you accumulate the needed funds.
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While there are a few differences, the structures for conventional small business loan transactions are similar to those of the unguaranteed portions of SBA 7(a) loans. One distinction is the excess spread available. Note, for 7(a) transactions, excess spread from the entire loan is available with only the unguaranteed portion being securitized, where for conventional business loans the entire loan is in the transaction.
Conventional small business loans are also made to “qualifying borrowers,” whereas the eligibility requirement of SBA loans is for borrowers that cannot obtain this financing. Therefore, the quality of conventional small business loans is generally better than SBA loans.
The average loan balance for conventional business loans for the most part will be higher than the SBA due to a lack of SBA limits on loan size. Also recall that SBA loans are typically floaters indexed to the prime rate. Conventional loans tend to be indexed to three-month LIBOR because the investment community prefers LIBOR floating rate bonds. Indexing the underlying collateral to the same index mitigates basis risk. SBA transactions have basis risk; however, the rating agencies take this into consideration when specifying levels of credit enhancement for deals.
Large portions of conventional loans are secured by first liens on real commercial property. Transactions will often consist of pools of loans backed almost completely by real estate collateral. When the loan is not backed by real estate, losses on defaulted loans will typically be higher due to the lack of real estate collateral, which is generally an appreciating asset, versus collateral such as equipment, which is a depreciating asset.
Prepayment penalties for conventional loans tend to be more severe than the SBA. Penalties are set by the lender and will likely start at 5% and step down one percentage point per year for the first five years following disbursements.
SBA transactions are generally more geographically diverse than conventional transactions. Forty-eight states could be represented in an SBA transaction where conventional transactions may contain only eight with around 70% of loan concentration in one state. Small business performance is negatively affected by downturns in economic cycles; the geographic diversity of SBA transactions lessens some of this risk.
Grace
Following graduation or withdrawal from school, Stafford, and Perkins borrowers are granted a period before the repayment of their loan begins. During the grace period, the government continues to pay the interest for subsidized and Perkins loans. For unsubsidized Stafford loans, the interest is still the responsibility of the student, who may request a shorter grace period to avoid additional accrual of interest. Grace periods for Stafford and Perkins loans are typically six and nine months, respectively.
Deferral
A deferral is a postponement of the loan repayment and acts similarly to the grace period. Interest accrues and the government pays it for subsidized and Perkins loans. However, for unsubsidized loans, the borrower is required to pay the interest or have it capitalized. Following are some circumstances in which students may receive deferment:
- Enrollment in postsecondary school at least half time.
- Economic hardship.
- Inability to find full-time employment.
The loan size varies from $1 million to, more recently, greater than $1.5 billion. Smaller loans allow for greater diversification and less credit risk, yet they are more difficult to analyze. Large-loan deals are typically purchased by buy-and-hold accounts, such as insurance companies and pension funds with real estate expertise, and often are preferred by these “real estate-savvy investors” as it is economical to spend the time analyzing the property.
Smaller loan deals (conduit) are more liquid and are typically purchased by total-return, mark-to-market investors that, lacking real estate experience, are more apt to rely on diversification and the rating agencies’ analysis and judgment.
Fusion deals, presently the most common type of CMBS deal, are “lumpy” conduit deals. Generally, a fusion deal has a few large loans that are typically shadow-rated investment-grade loans that are combined with a diverse pool of conduit loans. They grew in popularity after 9/11, which shut down the single-asset and large-loan type CMBS deals due to concerns that the risk of a terrorist act against one large property was too great. As a result, these large loans were split up and portions placed into various CMBS, thereby creating fusion deals. Much focus is placed on the top 10 and top 20 loans in any given deal as these can have a substantial influence on performance.
Concentration is important because it is sometimes difficult for the rating agencies to predict commercial loan defaults. The rating agencies use measures to score loan concentration and, accordingly, require more or less credit enhancement. For example, Moody’s uses the Herfindahl index to determine the effective number of loans within a pool. A pool of 100 loans that had a Herfindahl index of 65 indicates that the pool has an effective diversity of 65 loans.
Greater complexity in loan workouts is a result of increased diversity, both in the participants involved in financing companies and in the nature of financial claims. Traditional bilateral banking relationships are being replaced by more transaction-based financing arrangements, including the direct access to investors in the capital markets. As a result, when corporate distress occurs, there is a very wide range of institutions that become involved in support operations. Potentially conflicting objectives from a wide spectrum of financiers, including venture capitalists, credit insurers, institutional and retail bondholders and vulture funds, can be difficult to reconcile. At the same time, the complexity of companies’ legal structures and financial management activities results in a loss of transparency. Considerable effort is required to unravel financing arrangements if such companies encounter difficulties. The process of determining the prioritisation and negotiating strengths of the different claims on a company’s assets is hampered, causing uncertainty among the participants.
September 26th, 2008
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September 6th, 2008
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