It’s almost cliché at this point in the year to reflect on the uncharted territory financial institutions (FIs) and their loan portfolios have navigated through.
The bad news: Banks and credit unions know their loan portfolios’ performance is deteriorating.
The good news: There are now better ways to manage the response in this market than there were during the Great Recession.
Unlike during the Great Recession, when over 600 banks and credit unions failed because of severe degradation of their loan portfolios (particularly commercial real estate assets, or CRE) as a leading cause, today’s secondary market for loan sales of sub/non-performing loans alike are increasingly being driven by modern platforms.
Not only does the market for sub/non-performing loans (CRE in particular) have more buyers than ever, the adoption of the internet to perform large transactions is driving transparency. The internet is connecting counterparties directly across asset sizes, industry types, and geographies without the need of a legacy team of brokers obfuscating the true economics of these transactions. In many cases, the bid/ask spread is not hidden at all.
In addition, some of the leading platforms have been utilized by banks as a key way to transparently test the market for prices on their loan portfolios, avoiding any costly and opaque third-party loan pricing mark-to-market model. By nature of the different revenue models of these platforms, this ancillary pricing need of financial institutions can be dramatically cheaper or even free.
The sale process is also a lot faster due to increased efficiency, which subsequently leads to less pre-payment and defaults during transactions. Through the nature of the internet, many platforms tend to centralize information and make data searchable. Although still not entirely automated, many bankers have become accustomed to managing the loan sale or mark-to-market process with dramatically fewer emails, phone calls, and spreadsheets.
The adoption of better internal data platforms has also made the loan trading landscape different since the Great Recession. With the advent of more advanced Core Platforms and Loan Origination Systems (LOS), data is widely available. Modern secondary market platforms tend to directly integrate LOS or core systems and allow easier loan data and document transfer. Ultimately, this drives faster transaction closing times.
The move online has certainly been part of a macro trend as more enterprise services demand digital alternatives. However, this particular trend may have been exacerbated by some legacy providers who pushed many depositories into severely distressed loan sales during the Great Recession.
Credit Crisis vs Earnings Crisis
The current downturn is also vastly different from the Great Recession in that now, banks and credit unions have time. Although the drop in liquidity and funding has devastated non-bank originators without a balance sheet, the picture for balance sheet lenders like depositories has been much different.
Most depositories have certainly taken a hit to earnings via large scale forbearance; however, they are not yet experiencing the full impact looming from large defaults in their loan portfolio. In addition, the reduction of the cost of borrowing brought on from various Fed actions and the rise in origination fee income as refinances bounce back has cushioned the earnings picture.
However, the key point is that there has not been a default crunch yet. It’s unclear how borrower balance sheets will look on the other side of the provided forbearance and government stimulus actions. Lenders aren’t out of the woods, but they have more time to prepare and manage their deteriorating credit quality than they did in the Great Recession.
For buyers in the loan market, these scenarios typically create opportunities. As we’ve seen in previous downturns, more sophisticated FIs typically sell better-performing assets while they can still receive relatively fair market prices for them. This typically affords buyers an opportunity to buy high-quality loan assets at slightly discounted prices. In addition, non-performing loan buyers typically also benefit. In previous downturns, lenders that waited too long to act, and found themselves in a tougher liquidity position, and had to sell assets that could otherwise have been repositioned or sold at higher prices.
Take Action Now
With better access to the national secondary market than ever before, there’s a real opportunity to manage loan portfolios more strategically this time around. And it begins with leveraging the greater access to liquidity and potentially even opportunities for loan growth before it’s too late.
This blog post was written by Pavleen Thukral. Pavleen Thukral is the founder and CEO of Stackfolio, an online marketplace for loan trading, and a Jack Henry partner.