By Kingsley Greenland, co-founder and CEO of Boston-based DebtX, the largest dedicated loan-sale advisor for commercial debt.
Weak economic conditions and a spate of high-profile bankruptcies continue to depress the normally robust secondary market for syndicated debt, but to the surprise of many institutions, the opposite is happening in the secondary market for whole loans.
Due to a confluence of events, liquidity has been flowing into the market for individual whole loans or pools of whole loans as new buyers seek debt to boost yield and diversify their portfolios. Just as surprising, this newfound liquidity is coming from an unlikely source: local and regional banks who simply weren't active in this market until now.
The emergence of the secondary market for whole loans says much about the growing sophistication of local and regional banks, but it is also a key development for large portfolio lenders who securitize loans. Instead of automatically opting for a loan securitization, lenders now have a complementary alternative to help them achieve similar objectives.
Confluence of Events Creates Liquidity
Increased liquidity in the secondary market for whole loans is the result of three distinct trends in the market: the accelerating adoption of technology, the necessity to find attractive yielding loans amid record-low interest rates, and the growing importance of portfolio diversification among banks.
The accelerating adoption of technology is perhaps the most critical development in creating liquidity in the whole loan market. The key technology breakthrough is that loan analysis, due diligence, and bidding can now all be done online. In much the same way as consumers buy books on Amazon or rare coins on eBay, institutions are purchasing individual loans or pools of loans online at an increasing rate. Online loan sales simply didn't exist several years ago.
Buyers benefit from a streamlined loan-sale process in two significant ways. First, buyers can eliminate the distraction and cost of visiting a loan seller to physically inspect loan documents and other records. Second, buyers can evaluate more loans in less time and thus have a greater number of purchase opportunities. As a result, buyers who couldn't participate in this market because they couldn't afford the expense, the lost management time or both, can now participate readily.
Sellers, an equally important part of the liquidity equation, are also taking advantage of technology. Online execution helps sellers price loans more effectively by giving them easy access to trading data on recent loan sales. It is also more cost effective to market loans electronically and to aggregate buyers in a single, online location. All these efficiencies have shortened the loan-sale process from 120 days to about 45 and provide sellers with an opportunity to complete multiple deals in the time it used to take to do just one.
Technology benefits are magnified by the fact that low interest rates have driven buyers to look at every opportunity to replace high-yielding loans that are repaid because of low interest rates. This has motivated buyers to embrace the secondary market for the first time as a source for acquiring attractive yields. Unlike syndicated debt, where prices are languishing because of the flagging economy, the vast majority of individual and pooled whole loans offer comparably good yields.
The Virtues of Diversification
The search for attractive yielding loans is part of the third major trend impacting the market: the realization that portfolio diversification improves performance. Long a favorite technique of stock managers, diversification is becoming a better-understood economic principle that can and should be applied to many different disciplines.
Diversification is proving to be a smart strategy in response to the twin pressures of maintaining earnings and reducing portfolio risk. By diversifying through loan sales, lenders are selling loans that are showing signs of strain in the continuing weak economy. Dispensing with these loans on the secondary market allows management to deal with problems quickly, rather than have those problems absorb scarce management time. Equally as important, diversification is helping reduce risk to certain industry sectors. This is particularly important with regard to commercial real estate as banking regulators scrutinize large concentrations of commercial real estate in light of rising vacancy rates.
By leveraging technology, loan sales become a high impact endeavor with minimal effort. In fact, local and regional banks in particular can achieve diversification with the sale or purchase of just a few loans.
The market for syndicated loans will no doubt rebound. But the good news is that the clock can't be turned back on the liquidity in the secondary market for whole loans. And that means market participants will continue to have another viable alternative to manage their portfolios.