Managing the loan portfolio while meeting customer demand
Stress tests in financial institutions are purposed to identify risk within the bank or credit union’s balance sheet. The hope is that, by recognizing these risks in advance of the stress scenario, the institution can make adjustments or re-balance the loan portfolio to mitigate some of the impact.
1. Whole Loan Sales. The 2006 guidance, “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” specifically identified whole loan sales as one option for managing exposure in a given portfolio segment. During the webinar, Jon recognized that pricing for loan sales is improving: nonperforming commercial loans have increased 500-1,000 basis points in the past year, and with the current low interest rates, legacy loans nearly always have yields higher than new originations, making older performing loans more attractive. Granted, most banks do still experience losses of 20 percent on book values.
2. Participations. With this option, the institution will sell interests in a loan in an effort to improve liquidity or to manage this portion of their portfolio. As with loan sales, a bank that engages in loan participations should be prepared to provide a complete analysis of the loan participation’s value, risk and credit quality. The selling institution should provide as much information on the credit as possible, the buying institution is required to independently assess the credit, including thorough documentation. For more information, see the Comptroller’s Handbook from this list of banking regulations.
3. Securitizations. This final option may carry some stigma from the financial crisis, but loan securitizations present bank management with another opportunity to manage portfolio segments and the risk therein. In this instance, the selling institution can package asset-backed securities as one way to address asset-liability mismatches and transfer risk to parties better positioned to manage them.
Exiting or selling businesses within the bank or increasing prices are other options for reducing the risk in the loan portfolio, but those options can hamper customer experience.
Institutions considering an asset sale should think through each of the following concepts prior to proceeding:
• What timeline and sales process is expected?
• What assets are the best to dispose at this time?
• How should you represent and warrant the assets in the agreement? This includes lie positions, performance, risk ratings and listing as a distressed versus non-distressed sale.
• How large of an audience is needed for establishing a market, and are files available to all these parties?
• How do you pool the portfolio, and is its data (operating statements, rent rolls, etc.) current?
• What is the expected closing process?
To learn more about how stress testing can lead to better capital adequacy evaluations, and risk-mitigating credit policies and procedures, download the whitepaper titled: “Actionable Stress Test Results for Community Banks”.
About Clark Street Capital and Jon Winick
Clark Street Capital is a full-service bank advisory firm, specializing in the review, management and disposition of complex loan portfolios. Their areas of focus include banking, CRE, whole loans, loan sales and workouts. Jon Winck is president of Clark Street Capital. Prior to founding Clark Street Capital, John was National Marketing Director for Zions Bank, a $53 billion bank headquartered in Salt Lake City.