VTI - Loan Sales Are Picking Up In Regional And Midsized Banks

2023-06-28 17:04:09 ET

Summary

• Regional and midsized U.S. commercial banks are increasingly selling their loans, including car and consumer loans, commercial real estate and special finance in an effort to gain liquidity and de-risk.
• This trend is expected to continue and potentially intensify, with experts predicting it could reach levels not seen since the 2008 Great Recession.
• The situation is reminiscent of Silicon Valley Bank's experience, which had to sell assets and take a capital loss due to rising interest rates and depositors moving to higher rates elsewhere, ultimately leading to its closure.
• Now, however, the concern that this "wave" will pick up!

Regional and mid-sized U.S. commercial banks are stepping up their sales of loans.

They are selling car loans and consumer loans. They are selling commercial real estate and special finance.

And, according to experts, we are just at the beginning of the effort.

As I have been writing, there is lots and lots of "cash" out there in the financial system.

There is not a lot of cash in regional and mid-sized banks.

In the Financial Times, we read

"This is the first inning. They [banks] are selling the assets that are their highest-quality assets and that are short-duration and floating rate."

"The next wave will likely involve the bid-ask spread coming down and will likely include non-core bank assets."

And, they are moving quickly.

"We will continue to see loan portfolios transact, potentially more so than at any time since 2008."

The year 2008, that was the first full year of the Great Recession, the recession that began in December 2007.

"This is a systematic move by banks to gain liquidity and de-risk."

The Model

We have seen this model before. Silicon Valley Bank (SIVBQ) had been aggressive in its lending, even during the times when interest rates were so low.

Interest rates rose, as the Federal Reserve was attempting to tighten up on monetary policy to fight inflation.

As the interest rates rose, it became harder and harder for Silicon Valley to maintain a positive spread on many of its loans. The bank had to raise deposit rates as the Fed increased market rates in order to maintain its deposit base.

But, deposit money left the bank as depositors moved to higher interest rates elsewhere.

Finally, the bank had to start selling assets and take a capital loss on the transactions.

The bank had to close.

And, this is the scenario hanging over the marketplace right now.

Are There Buyers?

The fact is, there is lots and lots of money out in the marketplace these days.

The reason is that the Federal Reserve, in attempting to protect the banking system, generated lots and lots of money into the banking system.

This recent report of mine will give you some idea of the amount of funds the Federal Reserve drove into the banks.

But, the monies generated in the banking system did not spread around evenly.

In fact, the largest amounts of money being created in the banking system went to the 25 largest domestically chartered banks in the banking system and to foreign-related banks.

The cash position of the rest of the banking system hardly changed.

The result: the 25 largest domestically chartered banks are running a cash position close to a historical high. Same with the foreign-related banks.

The regional and mid-sized banks are looking for money.

Again, Silicon Valley Bank is an example.

in order to generate earning and get into desirable markets, the bank, even when loan margins were extremely low, made loans...and made loans...and made loans.

The loans were financed, to a great extent, by funds carrying an interest rate near zero.

When the environment changed, when inflation started to raise its head, the Federal Reserve started to raise its policy rate of interest.

Silicon Valley Bank and many regional and mid-sized banks found themselves in trouble.

And this is where many regional and mid-sized banks are today.

What to do?

Sell...sell...sell!!!

That is exactly what is happening.

And, where are these banks finding buyers.

Private Credit Funds

Funny you should ask. I just wrote a post on some of the sources of money to buy these loans. Private credit funds are and have been moving into this space in the last year or so.

And, they are not the only ones that are picking up these bank loans that are for sale.

As I said, there is lots and lots of money around because Private credit funds are not the only group of potential lender hanging around.

"Private equity investors...are also being asked to pick up the slack as regional banks pull back from buying loan portfolios that have been originated by specialty finance companies. KKR, for example, committed to buy $550 million of solar energy consumer loans from SunPower."

Banks used to be the source that would pick up these financial opportunities. Now, it is many of these other sources that are full of cash because so much money was put into the financial system by the Federal Reserve over the past several years.

The Banking System

This behavior, however, raises questions about what is going to happen to the banking system.

Regional and mid-sized banks are accelerating their effort to sell off their loan portfolios.

These financial institutions need cash and they need to protect their capital requirements.

This is the turmoil that is at the other side of the "asset bubble" that was created by the Federal Reserve.

Analysts have been worried about how the actions of the Federal Reserve over the past several years would work out.

Well, this may be the result.

Picture....

...a much smaller banking system in number, but with the industry becoming more and more composed of larger banks.

Remember, as quoted above, "This is the first inning."

Right now, the "best" loans are the ones being sold off. Keep looking for the time that the quality of the loans in the portfolios being sold begin to decline.

And, so on.

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