It's a Buyer's Market: Evaluating Secondary Market Loan Opportunities
ALM First shares potential benefits and best practices for buyers and sellers.
With more sellers than buyers, the loan transaction landscape remains a buyer’s market.
Broadly speaking, credit unions are struggling with liquidity and seeking funding for organic growth rather than focusing on participations. In addition to rising rates and increased loan production at rate levels that often didn’t keep pace with market changes last year, fewer transactions have also created more volatility in recent months.
While rates up production is helping, we still see many credit unions producing loans that don’t have enough spread to clear the secondary market. Using the secondary market can help depositories evaluate their own organic originations and potential participation opportunities.
Securitizations may also allow credit unions to tap into an investor base with a broader credit risk appetite. However, it’s important to remember that buyers of both participations and asset-backed securities will want to be compensated for the level of risk they are taking.
Regardless of the rate environment, developing a disciplined loan evaluation process to help originate profitable loans is critical for long-term success. The accompanying chart provides an overview of the steps required to evaluate different asset classes.
Potential Benefits and Best Practices for Buyers and Sellers
For credit unions that have liquidity, now is an advantageous time to be a buyer. Common reasons to buy loans include supplementing organic growth, diversifying the asset portfolio (by geography or loan type, for example), balance sheet management (with the goal of extending or reducing duration, or improving efficiency) and removing servicing headaches (if servicing is retained).
On the seller’s side, common motivations include increasing liquidity (through asset and liability management and access to the non-government sponsored enterprise, or GSE, secondary market), maintaining loan origination consistency, reducing risk (with a single-borrower interest rate, credit, concentration and regulatory limit), and gaining on the sale and/or ongoing servicing income.
Whether you’re a buyer or a seller, it always helps to start with the balance sheet in mind as participations can have a material impact. Ask: Will this transaction help my institution directionally or strategically?
Next, develop a consistent (risk adjusted, relative value) decision-making framework to ensure that your institution is being adequately rewarded for your risk (by way of credit, liquidity, etc.) and that your process identifies and mitigates risks. This may assist you in the long-term with both loan pricing and sales.
Last, be sure to identify and empower key stakeholders to own the process. The finance, credit and legal areas of business all have a part to play in loan transactions. It’s important to ensure that everyone understands their role to safeguard the best interests of the organization.
Looking Ahead
Forward-thinking institutions are beginning to look at downside protection for variable rate products tied to prime, such as home equity lines of credit. While none of us know exactly what the future holds, we do know that at some point rates will go down again. Hedging can help protect against downside risk.
Now is also a good time for credit unions to consider their allocation from a fixed versus variable rate perspective. Variable products are generally the most attractive before rates rise. In today’s environment, managers should look at both the up side and down side of such products.
For depositories looking for a wider audience or geographic diversification, third-party originators may also be worth evaluating. Potential benefits include access to rates up production, saving time and costs on loan processing, automating data collection from borrowers, verifying compliance with regulatory requirements and streamlining applications.
While a disciplined loan evaluation process is always important, having such a process in place to help originate profitable loans has been even more critical in the current cycle as rates and markets have shifted quickly. We encourage credit unions to regularly evaluate all asset classes relative to their specific balance sheet needs.
