ALM First’s work with several hundred depository institutions nationally allows the firm to identify the potential impacts of emerging trends and provide unique perspectives on the market. For example, last fall we addressed how mispriced assets were fueling a liquidity crisis.
Now, as financial institutions take a fresh look at the importance of liquidity management after recent bank failures, we’re seeing securitization demonstrate a growing acceptance as part of a forward-thinking institution’s liquidity toolbox.
Here, we’ll provide some important context and a few tips to help your depository better understand the pros and cons of securitization.
Securitization Trends, Potential Benefits & Risks
For high-volume lenders, securitization provides access to deeper and wider capital markets, paving the way for future scalability, more liquidity and better pricing. In our role as a strategic advisor, we have advised on several industry securitizations, acting as the institution’s advocate from the initial idea stage to the broker-dealer selection, ratings agency process, and maximizing deal economics.
Securitization requires a larger size sale to overcome higher fixed costs but allows your depository to gain access to a significantly larger investor pool. Your institution is only required to retain 5% and standardized data and legal docs make future sales more scalable. It’s important to note that available sectors are more limited than participations and therefore only appropriate for certain asset classes.
The objectives of securitization typically include efficiency for highly liquid asset classes, profit, and scale. As the seller of a securitization, you earn your premium through retained notes and servicing rights rather than cash up front. There are nuances to this that should be understood before proceeding, along with other key differences from the more common participation route.
The lead time to securitization exposes the seller to interest rate risk between when the loan is originated and when the security is issued. This risk is also present in participations between the moment the loan enters the “for sale” pipeline and is ultimately sold to a participating institution. There are methods to manage pricing risk, including the use of derivatives to help counteract changing market yields, but may not help to offset other pricing factors such as spread changes.
Failure to sell is another risk common between participations and securitization. Whether a conscious decision to halt progress of a transaction, the inability to complete a transaction due to counterparty failure/contract negotiations, or other event, sunk costs including time and expenses can be very costly to the institution. It is best to thoroughly understand the process and requirements of each type of transaction before committing resources across various departments.
Key Takeaways & Best Practices
Regardless of the secondary loan strategy your depository chooses, we recommend starting with the balance sheet in mind. Does this help the institution directionally/strategically?
Next, develop a consistent decision-making framework (e.g., risk-adjusted, relative value) to determine which approach is best for your institution and adequately rewards you for risks taken.
To be successful, you must identify and empower key stakeholders to own the process. Finance, Credit & Legal all have a part to play and ensuring everyone is ready and understands their role will make securitizations go more smoothly.
Lastly, always document your analysis and decision process. Make sure you have something to refer to with future examiners and other stakeholders.
Contact us today today to learn how ALM First may assist your institution with evaluating secondary market loan strategies.
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The content in this article is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. While such information is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. Statements herein that reflect projections or expectations of future financial or economic performance are forward-looking statements. Such “forward-looking” statements are based on various assumptions, which assumptions may not prove to be correct. Accordingly, there can be no assurance that such assumptions and statements will accurately predict future events or actual performance. No representation or warranty can be given that the estimates, opinions or assumptions made herein will prove to be accurate. Actual results for any period may or may not approximate such forward-looking statements. No representations or warranties whatsoever are made by ALM First Financial Advisors as to the future profitability of investments recommended by ALM First Financial Advisors.
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