As of January 31, 2021 more than 1,700 credit unions list balances from purchased participations and over 850 Credit Unions list outstanding sold participations on their balance sheets. It may be a seller’s market currently, but there are still opportunities for both buyers and sellers to thrive.
Why Do Sellers Sell?
Even in an environment where institutions are challenged to grow loans, there are many reasons that a credit union may choose to sell loans. The most common include: maintaining loan origination consistency, reducing risk (interest rate, credit, concentration and regulatory limit to single borrower), increasing liquidity (asset and liability management & access non GSE secondary market), and gain on sale/ongoing servicing income.
Why Do Buyers Buy?
While the economic outlook is much more optimistic as we move forward in 2021, your institution may still need to explore new avenues for loan growth. Here are a few of the most common reasons to buy: supplementing organic growth, diversifying asset portfolio (geographies, loan type), balance sheet management (extend or reduce duration, improve efficiency), and removing servicing headache (if servicing retained).
High performing institutions understand the importance of evaluating all asset classes when constructing their balance sheets, including whole loans and participations. Just like a securities investment or loan origination, incorporating loan transactions into balance sheet strategy can often improve institutional performance.
Evaluation Tips for Both Parties
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. Does this transaction help your credit union directionally/strategically?
Next, develop a consistent (risk adjusted, relative value) decision making framework to ensure that your institution is being adequately rewarded for your risk (credit, liquidity, etc.) and that your process identifies and mitigates risks. This may assist long-term with both loan pricing and sales.
Identify & empower key stakeholders to own the process. Finance, Credit & Legal all have a part to play. It’s important to ensure that everyone understands their role to safeguard the best interests of the organization.
Best Practices for Sellers
Successful sellers determine who owns the process internally and get their due diligence items organized for potential buyers. These include:
- Loan policies and procedures
- Credit/static loss history
- Show info by FICO tier, term, etc.
- Historical prepay speeds
- Electronic loan files
- Your depository’s financials.
As a seller, it’s also important to have your standard legal documents drafted and ready, including:
- Non-disclosure agreement (NDA)
- Letter of intent (LOI)
- Loan participation agreement (LPA).
Best Practices for Buyers
Beyond ensuring that the transaction is a strategic fit for your credit union, as a buyer, we recommend ensuring that you have:
- An updated participation policy in place
- Developed a decision-making process
- Determined who owns it – including both your finance and credit/lending teams.
Successful buyers should also ensure the following is part of their process to evaluate participation opportunities:
- Utilize loan level analytics/modeling vs. averages
- Stress assumptions
- Consider balance sheet/strategic fit
- Consider risk adjusted relative value
- Create a due diligence check list
- Counterparty due diligence
- Loan level/portfolio due diligence
- Legal review of documents
Buyers should be wary of structured participation pools, geared to have attractive yield, relative to averages (FICO, LTV, DTI etc). Get the loan/data tape and run loan level analytics to gain better transparency into true economic value and balance sheet fit.
Lastly, it’s critical to remain aware of the macro/micro economic factors impacting loan value & performance. Primary and secondary loan markets are dynamic and some sellers capitalize on less knowledgeable buyers. Don’t skimp on the analysis and be sure to save/memorialize it along with your stressed assumptions and a record of your decision-making process when purchasing so that you may refer to it later with future examiners and other key stakeholders.
Travis Goodman is a Principal at ALM First Financial Advisors, joining the firm in 2003. Travis oversees the Advisory Services department, which is responsible for implementing actionable and effective ALM and investment strategies for client financial institutions. In addition to overseeing Advisory Services, he assists large, complex financial institutions in achieving optimal performance within policy and risk tolerances.
Travis has a bachelor of science degree in business administration, with a double major in finance and marketing, from the Eller School of Business at the University of Arizona in Tucson. He also holds the Chartered Financial Analyst (CFA) designation.
Kevin Shaner joined ALM First in 2018 and currently holds the position of Managing Director, Loan Transaction Network and is also responsible for the national banking channel. Kevin has over 20 years of commercial and corporate banking experience and has originated, underwritten, and managed billions of dollars in the primary and secondary loan markets, across a wide variety of loan types including: government contracting, C&I, CRE, SBA, construction, project finance, auto, and residential mortgages. Notable public transactions include the $1.2B REIT conversion of Host Marriott, the Smithsonian Institutes $100mm+ acquisition of the Victor Building as well as co-managing the IPOs of SAIC and SRA.
Prior to joining ALM First, Kevin served as Managing Director, Bank Assetpoint for Promontory. He has also worked at national, regional, and community banks, including Citibank, Bank of America, BB&T, and Wells Fargo where he was formally credit trained.
He passed his Series 7 & 66 license exams and is a Registered Investment Advisor. Kevin earned his degree in Communications from the University of California, San Diego.
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