Regulatory pressure that has led to some scaling back of the government-sponsored enterprises and developing rules like the qualified mortgage and qualified residential mortgage definitions are among the reasons
“The loan trading is definitely picking up,” said Usell, managing director, W.J. Bradley Financial Services. “It’s going to continue picking up as agencies wind down.”
As the guarantee fees for loans sold to the agencies go up, investor can get relatively more attractive yields from a whole loan execution.
In addition, how banks hold and classify assets is playing a role. Given the relatively tighter rates seen this year, originations have been relatively lower and banks have been looking to acquire more loans to shore up their balance sheets.
And banks are particularly influential because their cost of funds structure given the recent relative steepness of the yield curve gives them an advantage. It allows them to obtain money to buy or finance longer-term assets with relatively higher yields at relatively lower short-term rates.
“Bank portfolios, in a sense, can outbid the marketplace based on their cost of funds structure,” he noted.
Because banks’ portfolio loans and can keep them on the books at par long-term—unless they are deemed uncollectible—with relatively little strain, their presence encourages whole loan trades as opposed to securities, which in a rising rate environment, would have to marked-to-market lower on their balance sheets.
At the same time lenders, who have seen some volatility in investor appetites for loans this year, are looking to have multiple outlets for their mortgages.
“There are a lot of different dynamics going on,” he said. “All of that lends itself to loan trading in general being a much bigger part [of lenders’ exit strategies] for loans.”
Usell said there have been banks that recently have been buying some agency CRA loans on a servicing retained or released.
Interest in buying or shedding servicing also is spurring some loan trading into today’s market.
For example, one needs to be an approved Ginnie, Fannie or Freddie servicer to own servicing and not everyone wants to meet the net worth and other requirements to do that. Also some loan portfolio investors want to own interest-only strips of loans similar to servicing as a hedge.
Because of the factors driving the market toward more loan trading, Usell said there have been more entrants, and W.J. Bradley is no exception.
“We’re currently building out the infrastructure for transaction management and then the servicing transfer pieces,” he said. The company may also hire or retrain a loan trader or two for sales.
The option of buying or selling servicing released or retained is part of the infrastructure challenge and part of the challenge in general in loan trading, Usell noted.
The preferences of the buyers and seller may not always match up. WJB, for example, likes to retain when it thinks the trading terms or correct for it as there are legal and compliance costs involved in selling servicing released. But it also know if it wants to sell CRA or other loans to banks they may prefer to buy the servicing with the loan because the customer contact is key to them.
“I can see as agency production goes down, we are going to have to learn how to trade loans pretty quick,” he said. “Institutions that are regional, the trading shops that have broad and deep bank sales forces should do well as things need to start trading as loans.”
He said most trades are getting pieced out based on geographic collateral characteristics.
The types of firm that can take advantage of this are small and regional banks as well as those who work with them.
He predicts a shift away from securities trading toward loan trading, which he said is relatively easy for individuals with a background in both areas, but it can be a difficult transition for corporate entities. New systems have not quite gotten off the ground and existing systems require considerable investment infrastructure.
“With a CUSIP you only take market risk, when you are trading loans there are reps and warrant, purchase and sale contracts (etc.),” Usell said. “The barriers to entry into loan trading are much, much higher. It’s going to be pretty interesting.”
“When you pull up a CUSIP pricing is very transparent.” Loan trading, in contrast, has little in the way of standard pricing and technology.
