Credit Alchemist

A small bank based in Prinsburg, Minn., has created a $500 million loan acquisition business by purchasing the unwanted loans of other banks. During the last 25 years, PrinsBank has managed its loan acquisitions so well that the business now dwarfs the $110 million bank's traditional banking operations..During the 1980s, PrinsBank worked through many troubled agricultural credits, as did many banks in rural areas. Located about 100 miles west of the Twin Cities, the bank learned lessons that would help it develop a new line of business. Looking for ways to deploy excess capital, PrinsBank approached a large bank about purchasing some of its troubled loans. "They thought it was a fantastic idea to sell them to us," said Mike Mulder, PrinsBank's president. The bank purchased its first 25 loans with a face value of about $500,000, in November of 1987..PrinsBank completed the purchase thinking it would be a one-time transaction but then it realized this kind of sale would work with other financial institutions as well. The bank approached a second large bank and received a response much like it had the first time. "They told us they were willing to part with them if we were willing to pay some money for them," Mulder said..The bank's first transactions went well enough that it looked for more. It soon found that banks sell loans for all kinds of reasons. For instance, when one bank acquires another, there is often a pool of loans that neither buyer nor seller wants. Banks also sell loans because they have new management with a new lending strategy. PrinsBank started selling its expertise to help banks price such loans, and in some cases it purchased the loans. In 2004, the bank acquired $60 million in discounted healthy loans from a bank exiting loans related to the bird-flu virus. In recent years, banks have even sold performing assets to meet capital or liquidity requirements mandated by a regulator. "We've purchased from the FDIC, large banks, community banks and insurance companies," Mulder said. "Virtually every loan we have ever purchased has been at a discount.".PrinsBank has competed for loans from the FDIC since the beginning. In the early 1990s, it purchased loans through the FDIC's Resolution Trust Corporation, the agency charged with liquidating the assets of failed savings and loans. "Those spread us through every state in the union," Mulder said. The bank continues to purchase loans from the FDIC today. "We wish there were more sales from them. Many of those loans are performing; it's just that the assuming bank didn't want that relationship," he explained..Looking for quantity over quality.While the bank's first transaction was relatively small, today the bank's average loan portfolio purchase is around $55 million. From the beginning, Mulder and his partners realized transactions of this size carry significant risk. If they were going to be in the loan acquisition business, they needed to protect PrinsBank from the risk. So they created PSB Credit Services. While PrinsBank purchases the loans and services them, it sells participations to PSB Credit Services. "We only house the performing loans in the bank and participate out the non-performing loans to the investment side to protect the bank," Mulder said. .While the bank seeks to build long-term relationships with customers and hopes to hold onto loans for a long time, the credit company seeks to turn around loans quickly. It wants to realize the greatest return in the shortest amount of time. "We tell the borrower up front that we are a transition bank for them. We are not the bank to help them expand or buy the building next door," Mulder said. "We tell them directly that we do not want their deposit account and we do not want their relationship.".Instead of a relationship, "the goal is payoff regardless of the loan's performing or non-performing status," Mulder said. PSB Credit Services wants payoff as quickly as possible for three reasons. When PSB Credit Services is paid off, it realizes a return on its investment. All risk from a loan ceases with payoff and the payoff funds can then be recycled to purchase more loans. The ultimate goal is to be paid off as many times as possible in the shortest amount of time. It's not a business based on quality assets; it's a business based on volume..Driving for the greatest return.Not all loans purchased by PSB Credit Services pay off as expected. Obstacles to payoff range from uncooperative judges to unperfected liens and from a borrower's continued failure to make payments to a short sale or foreclosure situation. It is PSB Credit Services' ability to avoid, manage and overcome these obstacles which makes the business profitable. That success starts with the due diligence process that precedes the purchase of every loan..PSB Credit Services prepares an exit plan for each loan it considers purchasing. These preparations help minimize risk. PSB Credit Services forecasts the possible outcomes of the loan and tries to foresee which outcome is most likely. "We look at the possibility of negotiating a short sale and at the likelihood of the borrower's recovery [if it is a non-performing loan]," Mulder said. "We build a model for every loan we purchase.".The market situations that PSB Credit Services can encounter are many and varied. It has developed sophisticated accounting systems and mathematical models to analyze each loan. "We have refined our mathematical models and developed software to track the loans and service them," said Cara Mulder, Mike Mulder's eldest daughter and vice president at PrinsBank. Cara Mulder came to work for PSB Credit Services in 2000. She helped develop the mathematical models that allow the company to compare one outcome to another..While these forecast models are excellent tools, PSB Credit Services' strategy is not impervious to losses. To further avoid risk it employs a method familiar to community banks. "Don't buy loans based on properties or people that you know nothing about," Cara Mulder said. "We go through the process as if we were originating the loan for the first time.".But PSB Credit Services does more than make a careful credit decision; it reviews each loan with a fine tooth comb. In addition to reviewing the loan documents and customer financials, the company reviews the status of taxes, the status of court rulings on the collateral, confirms lien perfection and lien position prior to pulling the trigger on a purchase. PSB Credit Services will conduct this due diligence even if the loan is only for $2,000. "Our team physically looks at every loan," Cara Mulder said. "We look at every file and view the property in person. We want to know the borrower. We want to see the property.".PSB Credit Services' credit analysis systems are housed on the internet; this gives the company's 30 staff members the mobility to access loan information from anywhere, a useful feature for people who are looking at collateral all over the country. The systems include officer comments, collateral information, insurance info, tax status and the contact information for its brokers, realtors and attorneys across country. "We can access it where ever we are," Mulder said. "It really has allowed us to still be located in Prinsburg.".Some risk always remains.PSB Credit Services' due diligence is exhaustive but it cannot remove all the risk. PSB Credit Services is never able to communicate with borrowers during the loan sale process; it must make some assumptions about the borrower's future behavior prior to purchasing the loan..Yet, PSB Credit Services still has two big advantages over the originating bank: It has more time and less regulation. While PSB Credit Services wants to see the loan pay off in three to five years, it does not have the same time crunch as the selling bank and can modify the loan for the borrower.."The selling bank is usually under regulatory pressure to clean up the loan," Mulder said. "These banks have little they can do to help a struggling borrower. Once it is on their classified list, it has to be resolved by leaving the bank's portfolio.".PSB Credit Services has found that the borrowers who made it through the recession are very committed to the success of their business. "They are still making their loan payments but they can't get refinanced. We can work through it with them until they can get refinanced," Cara Mulder said..Overcoming several risk factors, PrinsBank has developed the staff, systems, procedures and expertise essential to a profitable business model. "We never thought this was going to be a major focus 25 years ago," Mike Mulder said. "Now we refer to the bank as the tip of the iceberg; the larger activity is going on below the water's surface."