Old Kent Solves a Widespread Problem
Sells Refinanced Mortgages, Keeps Servicing, Invests Proceeds
Old Kent Financial has found a solution to a problem facing all banks: how to find assets with an acceptable payoff when loan demand dries up.
To compensate for the falloff in loan demand since last year, the Grand Rapids, Mich., bank is stepping up the origination of mortgage loans, selling them, keeping the servicing fees, and pumping the new cash into an investment portfolio.
The result is slightly more leverage, a higher risk-adjusted capital ratio - a sky-high 12.70 in the third quarter, up from 12.20 a year before - and a bigger war chest for acquisitions, which are part of Old Kent's game plan.
A Shifting of Risk
Right now, that looks like good business even though it entails exchanging credit risk for interest-rate risk - a switch most bankers swore they would never repeat after the banking debacle of the early 1980s, when assets and liabilities got way out of whack.
"This is an excellent way to get a big bang for the capital buck," said Richard Wroten, the bank's recently appointed chief financial officer.
But even Mr. Wroten acknowledges that pouring money into an investment portfolio is not a long-term strategy. For starters, the payoff isn't there: the margins are narrower than loans, which hurt interest income.
Potential for a Problem
Eventually, the failure to generate new loans could dent return on assets, because the bank won't be adding high-margin assets. Old Kent does not want that ratio to slip below 1%, the mark of a high-performing bank. When credit demand returns, Old Kent plans to return to its customary level of lending. Since January, Old Kent has made and then sold about $500 million of mortgage loans to Federal Home Loan Mortgage Corp. The banks reported a gain from those sales of $1.4 million last quarter.
By continuing to service those mortgages, Old Kent earned another $1.2 million during that time. The $2.6 million earned from both activities is more than double the total at the end of the first quarter of 1990.
Helping Old Kent's strategy is the recent spree in mortgage refinancing, as consumers take advantage of declines in fixed interest rates. Volume is up 30% over last year's level.
At least half of those loans are refinancing deals, done to take advantage of the low interest rate on fixed loans. Old Kent and other banks have been selling these low, fixed-rate loans to cut their exposure to risk when interest rates rise.
The bank has pumped the servicing fees, along with the gains on mortgage loan sales and other earnings and deposits, into securities. In the past 12 months, Old Kent has fanned the bellows of its investment portfolio by $1 billion.
Mr. Wroten said the portfolio has an unrealized gain of $85 million, which could be used to help in an aquisition, or to fund loans if demand arises.
A Cautious Strategy
Old Kent's strategy of eschewing questionable loans for safe treasury bills and municipal bonds is akin to that of other banks.
"It's a prudent strategy," said Virginia Adair, an analyst with Merrill Lynch. "There is not a lot of loan growth, so rather than atrophy the loan standards, they are sitting back on the throttle."
But Old Kent has taken a firmer line than most on making loans to all but the soundest customers. Some other Midwest banks are trying to increase their consumer loans, or are buying small portfolios of car loans, Ms. Adair said.
"What Old Kent is doing is the only thing you can do in these circumstances that makes sense," said Michael Milunovich, an analyst with Robert W. Baird in Milwaukee.
By selling of mortgages, Old Kent protects its capital ratios - among the highest in the country - because the balance sheet is kept in check.
As long as the Grand Rapids bank can service those mortgages efficiently - and it is adding technology to help - the strategy is sound.