A New York-based investment banker said he's noticed an uptick in his bank and credit union clients selling mortgages to the secondary market, especially when the loans aren't performing.
"Right now, the mark-to-market value on a nonperforming loan may be as good as it will ever be," said Pete Duffy, managing director at Sandler O'Neill. "Unless the owner goes current again, the credit isn't getting better. And if rates go up, market value is definitely going down.
Many of the troubled credit union loan portfolios Sandler O'Neill has handled have been acquired as the result of a healthy credit union merging a troubled one," he said.
Nizar Hashlamon, executive vice president of client relations for Prime Alliance, said it's a general rule that a credit union merging in a troubled one would analyze the newly combined portfolio's risk.
"If there's a good chunk of loans that aren't performing, instead of spending time and resources trying to resolve them, it's often better to start clean, and there are plenty of entities willing to buy them now," he said.
Duffy said considering there were 382 credit unions rated CAMEL 4 or 5 as of Sept. 30, there's still plenty of merger work to be done, which will include clearing bad loans off the industry's books.
And then there's the threat of interest rate risk. The men agreed a lack of investment yield and sluggish loan demand in other categories make giving up 3.5% on a performing loan a difficult choice.
"So many CFOs would love to keep them, but not at this risk," Hashlamon said. "Especially mortgages originated after the meltdown. Any new loan picked up in the past three to four years has been performing very well."
The risk is selling the loan at a loss, he said, because when rates rise, the secondary market will expect the asset to be discounted.
Duffy said his clients aren't frantically selling off mortgages, but rather analyzing whether they can afford such losses. Banks, which face higher capital requirements, are being especially proactive. Many are selling off more mortgages as they're originated, and some are securitizing mortgages and selling them off gradually, timing the sales as the balance sheet allows, shortening the overall duration on the books.
Hashlamon said even small credit unions are realizing they need to sell off at least some new mortgages to the secondary market, and the government service entities, Fannie and Freddie, are the only buyers that will allow credit unions to retain servicing rights. The philosophical belief that credit unions serve their members drives the desire to service mortgages originated at the credit union.
Fannie and Freddie are also working with credit unions on forward sales, Hashlamon said, allowing credit unions to lock in the deal–including the rate–when the member does, avoiding the risk that rates may rise while the loan is closing.
Another factor in interest rate risk is the potential for congressional reform of Fannie and Freddie, which are under the control of the Federal Housing Finance Agency due to conservatorship.
"If Wells Fargo or Bank of America become major buyers of loans, they won't pay as well as the government," Hashlamon said. "That high market price would go away."
And, another problem for credit unions keeping long term assets with low rates on the books is that they require another investment to hedge against that risk, and credit unions don't do that.
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