Current Market Snapshot: Contrarian Perspective - Low NPL, High Pricing and CECL Seen Driving Bank Loan Sales

October 2021

Volume and Loan Mix: Another solid quarter is in the books with consistent deal flow and high trade rate. The asset-class mix has shifted from hotel dominance to a more traditional mix, including office, multifamily, retail, and owner-occupied industrial. The quarter also saw more banks exiting small balance commercial and residential loans, along with an eclectic mix of CRE and business-oriented credits including mining, marine, agriculture, event venues, auto dealerships and churches.

High Pricing and Record Low NPL and Charge-offs Seen Driving Bank Loan Sales: Counterintuitive perhaps, but we can’t help but notice this burgeoning trend. While NPL buyers stare forlornly at bank call reports bare of NPL, we’re finding many bank clients scouring the balance sheet for substandard loans with an eye toward a secondary market exit. We see several factors driving this trend.

• Most in the industry thought that Covid-related losses would be much more severe and now find themselves with record low NPL, and non-accrual metrics, and sometimes excess reserves.
• This has resulted in a shift of focus to substandard loans; special assets “shadow inventory” not reflected in reported NPL; and non-accrual metrics.
• Banks are attacking the shadow inventory to exit tomorrow’s problems today, while NPL and charge-offs are low.
• C-Suite executives focused on CECL see an additional boost as most exit loans would have otherwise contributed to a higher expected loss under CECL guidelines.
• High pricing from an accommodative secondary market facilitates the exit strategy, often at pricing above existing book value.

It takes two to tango of course, and this trend will last only as long as capital demand exceeds supply and prices remain high. For now, many of our bank clients are tapping into this hot market repeatedly while the fun lasts.

Repeat Sellers Becoming the Norm: The repeat bank seller universe is growing. Historically, most banks sold substandard and classified loans rarely, or not all. Sure, some banks have always sold loans as a part of their portfolio management strategy, and many of these have been DebtX clients for years. However, this was the exception rather than the rule. We see this slowly evolving, evidenced by the number of repeat bank sellers in 2021 alone. Small and mid-sized banks are now discovering how easy it is to access a deep pool of secondary market capital available to buy loans. This trend is undoubtedly influenced by pricing, discussed below.

Loan Sales Above Net Book Value: This is an interesting dynamic that we’ve been seeing in our loan sales recently. In working with our bank clients, we’re identifying more situations where banks can exit substandard credits at or above book value. We wouldn’t go so far as to call it common (yet), but it’s been happening a lot recently and clearly contributing to secondary market volume. If you’re a banker thinking about loan sales, below are some common characteristics.

• Substandard loans with some degree of impairment, but generally not a disaster at the loan or collateral level (closed company, 100%+ LTV, bankruptcy, etc.).
• NPL on a select basis, but most loans have some payments being made, albeit modified, late, partial, or sporadic.
• The loans are generally deemed as exit credits. Loans and/or borrower that the bank would make no effort to retain.
• Usually CRE secured or single-family residential loans. Owner-occupied with an operating business (restaurant, auto/powersports dealer).