TWO-WAY STREET At the same time, there are all sorts of depository institutions that are looking to add loans. The root of their inquiries is that the desired mix of volume and quality can’t be filled internally. Again, it’s possible that concentrations are part of the dialog, and perhaps a given buyer is looking to add to a sector (for example, residential mortgages) where there is little opportunity in the local footprint. The matching up of sellers’ supply and buyers’ demand is what makes for the deep secondary market, and middlemen, such as ICBA Securities’ exclusive broker Stifel, can act as agents to connect the parties. These agents can assist in arriving at fair values for various loan blocks based on empirical data such FICO scores, risk-free rates, average lives and collateral. They also should have yield spread information on other, similarly structured recent whole loan transactions. Not least, they can assist with the sharing of information on the potential purchase/sale of given loans, including a sampling of loan files for underwriting and due diligence. BALLPARK ESTIMATES Of course, buyers of others’ credits would not have ever materialized if there weren’t adequate risk-adjusted returns. It’s difficult to estimate a range of incremental returns over the treasury curve for a given block of loans, as clearly, a portfolio will, by definition, not be homogeneous. However, it’s logical that the shorter the fixed-rate period (either to an adjustable reset date, a balloon date or maturity), the LOAN DEMAND HAS BEEN HEALTHY, AND, EVEN BETTER, CREDIT QUALITY HAS HELD UP VERY WELL EVEN THOUGH RATES HIT A 15-YEAR HIGH TOWARD THE END OF THE YEAR. lower required yield. Collateral will also factor in the yields; singlefamily residences have lower risk levels than do autos or commercial properties. Nevertheless, it’s not uncommon for a loan package to trade at 250 to 500 basis points (2.5% to 5%) over the curve. That being the case, there are several strategies that can be employed with whole loans as an investment. One is a leverage, in which wholesale funding is used to finance the purchase. Blocks of loans could produce net spreads over the related borrowings of 2% to 3.5%, which is a multiple of available spreads from investment securities. Also, buying loan packages with proceeds from a sale of underwater bonds can greatly shorten the “earnback” period, perhaps to within 12 months. There are more nuances to whole loan trading than we can adequately cover in this space. However, given that bank lending could be in a state of flux as the economy potentially slows, opportunities could arise for both buyers and sellers to benefit from these economic machinations. Finally, the start of 2024 gives whole loan market participants a full calendar year to realize and recognize the effects of the transaction. Jim Reber (jreber@icbasecurities.com) is president and CEO of ICBA Securities, ICBA’s institutional, fixed-income broker-dealer for community banks. INDEPENDENT REPORT | 13
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