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