Reducing Loan Portfolios Important in Rising Rate Environment, But How to Do it Best?

HUNTINGTON BEACH, Calif. – Credit unions with an abundance of loans have two primary portfolio management strategies: securitization through secondary mortgage companies like Fannie Mae or Freddie Mac, or whole loan sales on the open market. Deciding which strategy is best – or whether a combination of both is more suitable – was the subject of a presentation Joel Katz gave last week at the CU Members Mortgage 10th Annual Lending Conference. “When I look at a loan portfolio, the first thing I want to know is how many loans would qualify for Freddie Mac or Fannie Mae?” said Katz, managing director of Sandler O’Neill & Partners, a broker-dealer of loans. “Hands down, the best execution is to sell them to the agencies, because they’re worth a point to a point-and-a-half more than loans sold on the open market as whole loans.” How so? Because when sold to government-backed agencies, the credit union doesn’t have to offer discounts to offset credit risk, Katz said. “A 6.5% loan will find its way into a 6% security,” Katz explained. “Of the extra 50 points, 25 points goes to the servicer, which the credit union can retain, along with the income, and other 25 goes to the agency to guarantee the loan.” Katz added that with low-risk loans or loans with superior documentation, credit unions may be able to negotiate a lower guarantee fee with the government-backed buyers. Swapping loans for securities is smart strategy in a rising rate environment, Katz added, because securities have market values that are one to two points higher than the loans from which they are created. Additionally, because the agency assumes all risk, loan loss reserves can be released or re-allocated. Securitization isn’t for every credit union, however. The agencies will only purchase conforming loans, which are becoming less common in high value areas of the country like New York, California and Hawaii. Additionally, the credit union must be an agency-approved seller/servicer, with specific underwriting and servicing policies already in place. Another option for credit unions is to sell the loans wholly on the open market, Katz said. While this option doesn’t have the value of securitization, it is an option for credit unions unable to meet agency requirements. In addition, the loans are sold for cash, which comes in handy for credit unions wanting to invest in other businesses or infrastructure, Katz said. When selling to the open market, a credit union can work with a broker to put together a pool of loans that will both meet the credit union’s risk management needs and be appealing to buyers, Katz said. The broker sets a date for bidding on the loans. Then, interested parties submit their bids to the broker, and the credit union can select the best offer. Katz said that stipulations are just as important as price when selecting a bidder. Some buyers might have so many stipulations, the deal isn’t worth the price. Another option is to sell loans to another credit union, particularly one that already has a familiarity with the seller. “You can find someone you know through networking, like that credit union in the next county that needs loans, and do a direct negotiation with them,” Katz said.”There is less due diligence required, since you already know and trust each other, but you might not get best price.” Preparations for any loan portfolio sale are extensive and time consuming, the expert warned.”It can take anywhere from three weeks to eight weeks, depending upon condition of your loan files,” he explained. “No matter which option you choose, someone will come in and audit your loan files.” Katz added that some credit unions are too familiar with their members and don’t gather all the necessary documentation needed for a sale. “You might know that long time member from the golf course down the road, but the buyer doesn’t know that person at all,” he said. Believe it or not, there is a demand for sub-performing mortgage and consumer loans on the secondary market. Katz said he is amazed at how many interested parties call him on a weekly basis, asking to purchase delinquent loans, or even loans that haven’t made a single payment. “If you have `dogs’ on your balance sheet, there’s an active market for those loans, and they pay very rich prices,” Katz said, adding that the sub-performing market is currently “very competitive.” Katz said the secondary market for auto loans is also seeing an increase in demand, particularly in the southeast and northeast parts of the country. Much of the auto loans being sold are from indirect lending, although there’s no easy strategy to sell off auto portfolios. “A lot of credit unions want to know how they can liquidate their auto loans without taking a bath on them,” he said. “I tell them there’s no easy strategy, but it may be possible, especially as this market heats up.” Katz added that he’s also seeing increased interest in Home Equity and HELOC markets, as well. -