Jim Reber: Balance sheet, complete

Contrary to a multitude of reports, not all community banks are awash in cash in 2021. A number of ICBA member banks have been able to grow their loan pipelines, or at least maintain their cash positions—which remain annoyingly unprofitable—at manageable levels. Perhaps the avalanche of cash flows from the bond portfolio are past their peak, too, since mortgage rates have moderated somewhat in recent months.

Industry-wide statistics, however, paint a different picture. Between June 2019 and March 2021, loan-to-deposit ratios for banks with less than $1 billion in assets fell more than 10% (see chart, opposite). This is, by far, a majority of banks, as this metric includes more than 3,500 charters. While certain institutions have been able to keep their balance sheet relatively stable from an earning assets sector weighting posture, most would much prefer to be more highly leveraged in high-quality loans.

Diversify and conquer

Consumers and many startup businesses have long been accused of singing the “Can’t Get a Loan Blues,” which has mystified community bank lenders to no end. The opposite paradigm is at play today, as traditional loan demand has, in large part, been met by various government-sponsored programs, most notably the Small Business Administration’s Paycheck Protection Program.

Where does a community banker who’s interested in purchasing a collection of high-quality, high-performing, but nonconforming loans go to find such a package? The dialogue usually begins with prospective sellers realizing they’ve got a concentration issue of some sort—geographic, loan term or even product specific. Third-party loan analysts like Vining Sparks, ICBA Securities’ endorsed broker-dealer, can assist sellers in identifying marketable portions of a loan portfolio, including an estimate of the secondary market value and the pros and cons of retaining or releasing the servicing of the loans.

Blinders off

Once a package of loans has been identified for an originator to sell, the agent will assist in locating several prospective purchasers. It’s not unusual for a portfolio of $20 million to be distributed among four different community bank purchasers. The purchasers, for their part, and to their satisfaction, are usually able to review each loan file prior to settlement.

It’s common for them to have some latitude in picking loans that are favorable for their market footprint. I’ve also heard from loan investors that examiners are generally accepting of this strategy, especially if the buyer can demonstrate that due diligence was performed pre-purchase and the loans meet the buyer’s own underwriting criteria.

Popular demand

Several factors are at play that are increasing the number of community banks willing to buy another institution’s loans. First, traditional loan demand remains spotty at best and, as mentioned previously, many banks have an overabundance of deposits that need to be put to work. For another, buying loans can be a way for the purchaser to efficiently diversify its geographic or product risk. And credit quality nationally has remained astonishingly solid, so possibly the most obvious downside is within tolerable limits.

Of course, there wouldn’t be a secondary market for nonconforming loans unless they had higher yields than alternatives, which includes investment securities. That is certainly the case at the moment. There is a wide range of possible returns, determined by average lives, collateral and servicing arrangements, but it’s not uncommon for a high-quality loan package to have 150 basis points (1.5%) higher yield than a comparable bond. Secondary loan purchases can be a viable strategy for community banks seeking to build out a more complete balance sheet.