Volume and Loan Mix: The quarter ended on much the same note as Q1 2021, with consistent deal flow and volume approximately flat both by deal count and balance sold. Hotel loan sales remain prevalent, but a lower percentage of overall volume. Other loan and collateral asset classes have increased considerably. Banks are taking advantage of current secondary sale pricing to exit troubled residential loans, dairy and other agriculture loans, small balance commercial and the usual mix of multifamily, retail and special use loans such as churches, restaurants, and challenged healthcare loans.
Shifting Sale Dynamics: While many recent sales were largely strategic, with a focus on portfolio concentrations (hotel and healthcare loans in particular), we’re now finding many banks reviewing at a granular level. Banks are focused on troubled borrower relationships, the time and cost associated with long workouts or simply selling loans because today’s pricing is at or above net book value. This allows the bank to exit headache credits without any additional loss. Bulk sales were common when the FDIC was a massive asset aggregator and seller. But loan sales today, whether individual loans or pools, are tailored to achieve a specific portfolio objective or are targeted at the loan level, rather than just a dumping of credit.
Extreme Bargain Hunters Begin to Exit: Investor interest as measured by NDAs executed remains historically high, but has tapered a bit from our all-time high reached early in 2021. We attribute this primarily due to loan sale pricing. Many bargain hunters that entered the market in 2020 have been largely disappointed. The NPL wave never materialized, and pricing ended up looking more like pre-pandemic than anything close to the deep discounts of 2008-2012. We’ve seen this before and it’s a natural part of the cycle. After all, is there really a need to get that 10th bid if the Investor is 20-25 points low? We think not, it’s best to focus on investors most likely to be competitive in any given loan sale.
Looking Ahead: Forward loan sale predictions are difficult, and most have been wrong since the beginning of the pandemic, thrown for a loop by incredibly accommodative government/regulator/Federal Reserve policy. Excess demand and high pricing is evident in every market, including equities, high yield, residential loans, CMBS, CLO, MBS, etc. Banks are awash with liquidity. Competition for new loans is fierce, from competitor banks to non-bank lenders, many of whom leverage their positions with bank financing.
So, I guess everyone should just pack up and go home, right? After all, lenders have no reason to sell, and investors can’t find anything to buy. Well, not so fast. While the NPL wave predicted by many never materialized, the secondary market picked up substantially in Q3 2020. It has been relatively consistent since then. Market conditions and competition has kept pricing elevated. Most sophisticated banks have a solid handle on the true cost-benefit of a loan sale versus other outcomes. This combination has kept trade rates very high, close to 100% on some deals. We all remember the infamous “bid-ask spread” from the last financial crisis and recall how frustrating it was. Moving forward, we see several reasons to remain optimistic that deal flow will continue.
- Mergers and acquisitions have accelerated, and we expect this to continue. Our experience over the last 20 years is that bank M&A often drives loan sales as non-core and unwanted credits are jettisoned as a part of the consolidation effort
- If not by now, when? We’re hearing this often. Many banks are looking granularly at their loan books and find that notwithstanding massive stimulus, some credits have not rebounded, will never rebound, or will take much more assistance to do so. These loans are first in line to be sold.
- Market transparency and ease of access. Loan sales are still new for many banks, but our experience has been that once the first deal is cleared, loan sales are added to the workout menu for deals moving forward. Just recently we closed our first loan sale for a $30B bank, and they were back in market with another sale before the ink dried on the sale contract. This has been a consistent theme over the years. A loan sale is not the right path for every credit, but once introduced to loan sales as an exit strategy, most clients explore the option and take advantage of our free market analysis to help drive the decision.