CB Bancorp in Michigan City, Ind., has carved out a correspondent banking niche buying loans from mortgage banks with agreements to sell them back later.
The $172 million-asset thrift company has bought and sold at least 30,000 loans since it started its mortgage loan reverse repurchase program in 1990, according to president and chief executive Joseph F. Heffernan.
Last quarter, increased activity in the program helped boost the company's net income 35% from a year earlier, to $503,606.
"They've been very successful," said Wayne R. Bopp, an analyst with Stifel, Nicolaus & Co., St. Louis. "They realize they're small, and they've got to be different or do something better to survive."
The reverse repurchase strategy can increase profitability through the interest and fee income that the loans bring in, as well as reduce interest rate risk.
In turn, the mortgage banks get liquidity to make more loans.
It works like this: The bank buys whole single-family residential mortgage loans from mortgage banking firms. The loans are mainly the fixed-rate 30-year variety. It earns interest income from a rate tied to prime while it has the loans. Then, it generates fee income when the loans are resold, usually within 30 days.
"You essentially have taken 30-year mortgages and made them 30-day mortgages," Mr. Heffernan said.
The program is similar to "warehousing," in which banks fund loans made by mortgage banks until they can be sold on the secondary market.
"They kind of put a fancy name on a correspondent relationship," Mr. Bopp said.
However, the twists in CB Bancorp's strategy are the fact that it's a thrift - it owns Community Bank, a federal savings bank - and that it buys the loans itself and gets agreements to resell them, Mr. Bopp said.
One risk to the approach is that if CB Bancorp is unable to resell a loan through its prior agreement, it would have to sell it in the secondary market or put it on its books, which could hurt liquidity.
The company buys loans that meet secondary-market underwriting standards. But the company has not had resale agreements fall through, Mr. Heffernan said..
To limit interest rate exposure, CB Bancorp caps the program's loan investment at 50% of total assets and limits the maximum outstanding loan amount purchased from a single participant.
The success of the program also depends on interest rate and refinancing activity at any given time.
"As 1994 proved, it can go down dramatically, too," Mr. Heffernan said. "It is something if you can live with it giving you more volume in certain years."
As of June 30, mortgage loans purchased under resale agreements totaled $53 million, a $27.8 million increase in three months.
"Last quarter, when rates started coming down, they saw a big buildup," said Michael C. Burton, a securities analyst with the Ohio Co. in Columbus. "Earnings were really strong. A lot of that cash will carry into the next few quarters."
The loan reverse repurchase program arrived at CB Bancorp with Mr. Heffernan in 1989, and the first loans were bought in 1990.
He first orchestrated the strategy in the late 1970s, when he ran Heritage Bank of Oak Lawn, Ill.
The specialty has taken off. When CB Bancorp went public in December 1992, five mortgage banks were involved in the program. In June, there were 56 active participants nationwide.
In 1993, the company expanded the program to include interim construction loans, usually with terms of six months or longer, which totaled about $13.1 million on June 30.
Mr. Heffernan isn't sure why more thrifts aren't doing something similar, but said it may be the cyclical nature of an approach tied to refinancing activity.
Still, the niche has proved profitable to CB Bancorp. As the Ohio Co.'s Mr. Burton put it: "It's hard to be skeptical when you've seen the thing work."