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Bad Bank Loans Still a Problem Seven Years After Financial Crisis

Bad Loans Remain Well Above Pre Crisis Levels

SEP 23, 2015 3:07pm ET

The banking industry continues to sit on a mountain of problematic loans seven years after the onset of the financial crisis.

cloutier-babb-250Credit quality, to be sure, is substantially better than it was during the peak of the crisis. But the amount of nonperforming assets on banks’ books is more than triple the levels reported in 2006.

Banks have been more reluctant to offload a number of credits in bulk sales, and loss-share agreements have also forced banks to keep sour loans on their books. Low interest rates, along with a lack of better reinvestment options, have also influenced executives’ decisions.

Still, the continued existence of troubled assets could prove problematic should the banking industry face another economic downturn, industry observers warn.

Lingering bad credits “has been puzzling,” said Jon Winick, chief executive at Clark Street Capital. “The banking system and the economy would have recovered faster if there had been more emphasis on disposing bad assets rather than managing them. It has distracted a lot of organizations.”

Noncurrent loans and other real estate owned totaled $162 billion at June 30, based on data from the Federal Deposit Insurance Corp. While the amount was a 63% decrease from mid-2010, it nearly tripled the $56 billion reported in mid-2006.

A market exists for buying distressed assets, though bankers can expect to bring in anywhere from 20% to 80% of a loan’s value through such sales. Pricing hinges on the type of asset and the location and condition of the underlying collateral, said Warren Friend, head of product strategy and strategic client relationships at Situs.

Clark Street Capital and Situs are among a group of companies that have long sought ways to get problem assets off the books of community banks.

Many bankers, however, have been loath to take such haircuts, industry experts said.

MidSouth Bancorp in Lafayette, La., has never felt forced to conduct a bulk asset sale, said Rusty Cloutier, the company’s president and chief executive. Rather, the $1.9 billion-asset MidSouth prefers to work with its borrowers to find solutions.

“Being more of a community bank, we try to work with customers in good times and in bad times,” Cloutier said. “It is a good tool to have in your arsenal.”

Troubled assets can still earn money for lenders, Friend said. Banks must weigh the required capital and existing returns of an asset against what the lender could get by selling the asset and redirecting the capital.

“Banks have had a hard time keeping assets on their books,” Warren said. “Their view is that it is better to have a bad asset that’s earning something and working through it then to have no assets at all and only have cash that is earning zero.”

Banks that scooped up failed institutions during the aftermath of the financial crisis could have more opportunities to sell sour loans once their loss-share agreements with the FDIC end, said Randy Dennis, president of DD&F Consulting. An increasing number of banks in recent months have successfully negotiated early termination of their arrangements with the FDIC.

Finally, prolonged low interest rates and low funding costs have made it easier for banks to hold onto problem assets in the hopes of rehabbing them. Rising interest rates could pressure banks with elevated problem assets, Dennis said.

“The rates have been so low, so it costs basically nothing to carry nonperforming assets,” Dennis said. “We are behind in working through these. We will find ourselves in trouble if we don’t have some progress before rates go up.”

Banks are continuing to incur costs associated with carrying bad assets, ranging from paying staff to manage them to various legal and regulatory expenses, Winick said. Reducing problematic assets could also help banks get out from under regulatory orders, he added.

Existing issues could be exacerbated if the economy hits another major snag. The industry could suffer new losses or more bank failures. Still, industry experts noted that banks, by and large, have higher capital levels then they did before the financial crisis, which should help tremendously in the case of another downturn.

“At this point, banks have some leeway to sit on this stuff and work it out,” said Jeff Davis, managing director of financial institutions at Mercer Capital. He said, however, that an unwillingness to address past issues could create bigger headaches should new problems arise.

Issues with the energy sector, driven by a prolonged slump in oil prices, could serve as a test case of sorts for an economic downturn scenario.

Davis said banks with stressed energy books might be inclined to go ahead and “blow out existing problem credits that have been on the books for several years.” A bank’s view on whether more oil and gas nonperforming assets are coming will probably influence their decision, he added.

Perspective and proactive management matter, bankers and industry observers said.

Comerica, a big energy lender in Dallas, reported in July that nonperforming assets at June 30 were $370 million, or 23% higher than what it had a year earlier. While much higher than the $174 million in nonperforming assets Comerica had in mid-2006, the amount, as a percentage of total assets, remains well below the industry norm.

“It is important to remember that we maintain a granular portfolio with about 200 customers in our energy line of business,” Ralph Babb, Comerica’s chairman and chief executive, said during a recent investor conference.

“We have prudently increased our reserves for energy loans for the past three quarters as a result of an increase in criticized loans and the impact of continued volatility and sustained low energy prices,” Babb said.

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