The secondary market for buying and selling loans was formed in the late 1800s as the mortgage market in the United States grew following the passing of the National Bank Act in 1864. This market traditionally has been operated using highly bespoke transaction agreements and a relationship-based system of market participants.
Transactions in the secondary market occur for various reasons. Depository institutions may decide to sell loans for the purpose of balance sheet optimization, resolving issues with regulatory ratios, rate shifts in the market, or simply a need for liquidity. Non-bank lenders, and their traditional lack of cheap funding, have the need to sell their origination as a fundamental part of their business models. Other larger institutions like funds or real estate investment trusts (REITs) may take on the role of aggregating assets to sell in larger volumes down the line.
Financial institutions (FIs) look to buy loan assets for similar reasons. A depository may look to purchase assets to diversify its portfolio in sectors or geographies where it doesn’t have organic origination. FIs may also look to pad loan growth goals when deposit growth or availability of cheap capital outpaces origination. Non-bank buyside investors look to acquire loans to diversify into credit products that aren’t easily available in securitized forms. In addition, buying loans directly allows them to avoid hundreds of basis points of middleman fees taken out in the securitization process.
While the market is large, mature, and highly complex, it’s not efficient. A main issue is that although some slices of the market have evolved through securitization, including the conforming residential mortgage market and other niche loan products, the vast majority of loan sales are still transacted completely manually through “boots on the ground” marketing of portfolios that can take up to 9 months to complete. In the US, the secondary market for loans has remained relatively untouched by digitization. Until now.
A New Day for Loan Markets
Digital innovations in core platforms, loan origination systems, and internet data technologies have paved the way for this market to finally move into the 21st century. And everyone can participate. One example of this innovation includes free online marketplaces.
Online marketplaces for loan trading and participation offer significant advantages. Data transfer turns from a days-long task to minutes and loan documentation becomes simpler to put together and review. That makes due diligence - the longest and most time-consuming part of a trade - easier. Communication between buyers and sellers also becomes more streamlined and centralized.
In addition, these types of innovations are taking a transparency-first approach. The legacy loan trading market often hides the bid/ask spread from institution participants. This was unsustainable and it’s been removed through digitization in this size market.
The biggest potential of online marketplaces is in the increased liquidity and access it could bring to the market.
A huge problem in the secondary market today is finding a trade counterparty. Since marketing a trade is still a manual and relationship-based process, identifying qualified counterparties can take months.
A digital marketplace with enough participants has the potential to completely transform this process. It builds confidence in this future that a trusted advisor and core technology leader like Jack Henry is entering the space.
Bringing in Core Data
Core data also offers some incredible opportunities for easily finding buyers and sellers that would be a fit for transactions. In a world where data is more valuable than oil, in some ways, it is astounding that a core platform hasn’t already become the largest player in loan trading.
The online approach also has the potential to level the playing field between smaller and larger institutions. Legacy brokers have often been disincentivized to deal with smaller participants as loan trading is complex, no matter the trade size. So, their focus on larger deals with bigger commissions isn’t surprising.
Having buyers and sellers meet and close deals online will bridge this gap over time, particularly smaller institutions, that would have just as much national access as the larger trading institutions. And unlike the legacy process, no one would decide which opportunities get presented in an online marketplace.
With a technology leader like Jack Henry entering the market there should be growing optimism for institutions to increase liquidity and access to loan growth in the years ahead.
As with any other technology and marketplace, it will take the larger community of banks and credit unions to engage in the marketplace to make all of these advantages a reality. Hopefully the allure of free entry and core integration will accelerate adoption.