Commercial real estate lenders are quietly acknowledging regulators' fear of concentration risk by swapping out new loan pools with assets they didn't underwrite themselves and more often than not, they're paying a premium to do it.
Some buyers are so desperate to diversify their portfolios that they are barely making any money on the deals, according to Ricardo Diaz, head of fixed income at FIG Partners, an Atlanta firm that launched a whole-loan-trading desk in November.
"These deals aren't yielding a lot" for the buyers, he said. "They just need another liquidity outlet."
A number of banks are said to be nearing their internal concentration limits.
Bremer Bank in St. Paul, Minn., recently received the low investment grade rating of BBB on its subordinated debt, for which it paid Kroll Bond Rating Agency. Officials at Kroll said their analysis of the $3.6 billion-asset Bremer is "tempered" and they are "somewhat concerned" by the bank's commercial real estate concentration, which at 38% is double the size of any other type of loan in the bank's portfolio. Of the bank's nonperforming credits, 27% are commercial real estate, behind only residential mortgages.
The Federal Reserve and Office of the Comptroller of the Currency warned bankers last year about bloated portfolios of CRE loans, citing massive defaults that threw droves of banks into failure during the downturn.
Pools as large as $50 million are changing hands, officials at FIG said. They described the deal flow as swapping out commercial real estate product for various credits, including short-dated auto, marine and recreational vehicle loans, as well as longer-maturity jumbo home mortgages. Some banks might seek different types of commercial real estate loans than their currently holding. Those include construction, single-borrower, owner-occupied and tenant-occupied credits, such as strip mall and office loans.
Playing in Non-QM
Products in potential demand could include nonqualified residential mortgages, which have become hot items in capital markets in whole-loan form for balance sheet, trading book and conduit vehicles, including Morgan Stanley's and Goldman Sachs'. Morgan Stanley is said to have made at least three major loan acquisitions in recent weeks, people familiar with the trades said.
FIG has not decided whether the firm will source and trade that kind of mortgage given the many risks and moving parts, but it is a discussion Diaz and his colleagues are having.
Bigger trading outfits have also started to beef up their residential mortgage trading desks, as securities tied to them wind down in supply. Investment bank Cantor Fitzgerald recently named two Wall Street veterans, Gary Wang and Karl Partch, to its whole-loan-trading team based in Los Angeles.
"We view whole loans as the next scalable trade," said Cass Tokarski, a managing director at Cantor.
'Recipe for Disaster'
Any loans traded back and forth would receive a 100% risk-weighting. That alone could be a mitigating factor against too many of these trades taking place, yet there is still a fear that the opacity of the trades may irk investors.
"Most banks won't announce they are doing this publicly, and they don't want to tell their investors this is the route they are going down. But we're just satisfying a need out there," FIG's Diaz said.
Fitch Ratings analysts said they are starting to pay closer attention, but the activity remains in infant stages. They described the deals as conducted in a "lessons-learned" environment, citing the lead-up to the financial crisis. "You just kind of wonder from a regulatory standpointhow it will play out if you have one bank buying loans from a bank in another region or another part of the country," Fitch analyst Bain Rumohr said. The expectation is that the buyers would have to re-underwrite what they purchase.
Experts, including FIG's head research analyst Chris Marinac, are looking for regulators' approval. "We know there are multiple people getting in on this," he said. "People are chasing yield. Banks themselves want yield. Banks want other banks' paper. The question is do regulators police this?"
A senior regulatory official speaking with American Banker on the condition of anonymity claims banks haven't reached out to any significant degree regarding the direct participations. The official didn't seem bothered whatsoever when asked about direct participations involving commercial real estate.
Only one topic sparked a firm reaction.
"Out-of-region transactions they should not be in it," the regulator said. "That is just a recipe for disaster. That is what happened to a lot of banks in 2005-2006. They participated in credits way out of their market. If you don't know the borrower, if you don't know the economics of the market where you are buying loans, you better know what you are doing."
FIG claims most of its CRE trades will take place within locales or regions.
FIG has seen crossover interest between the loan and bond markets, including interested parties from out of region. Participants in loan transactions are said to be the same buyers and sellers that turned to the bond market for the first time this year.
Syndication agents on Wall Street claim they have seen more and more community banks acting as both buyers and sellers of each other's bonds, in a similar way that they have begun trading whole loans among one another. That market is transnational.
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Corrected December 26, 2014 at 4:54PM: This story has been updated to say Bremer Bank's "BBB" rating applied to its subordinated debt and that that is a low investment-grade rating, not the lowest. Also, the name of Fitch analyst Bain Rumohr was misspelled in an earlier version.