Troubled home loans written before the mortgage crisis still haunt banks' balance sheets, notwithstanding the sharp reductions they have made to loan-loss reserves.
Banks are continuing to restructure large numbers of residential mortgages because of stubbornly high unemployment and regulatory pressure to keep borrowers in their homes. A little-noticed charge taken by Regions Financial (RF) in the fourth quarter may portend that other banks have not been adequately reserving for these modified loans, known as troubled debt restructurings.
Regions took the $75 million charge to reclassify as held-for-sale $686 million of first-lien mortgages, all of which were considered performing but had been modified in some way. The $117 billion-asset Birmingham, Ala., bank says it wants to sell the loans to cut its premiums with the Federal Deposit Insurance Corp., which charges institutions higher rates for holding riskier loans.
Rita Sahu, a Moody's vice president and senior analyst, calls the Regions charge "a bad omen" for the industry.
"Broadly speaking, it tells us that other banks might have more charges associated with their troubled debt restructurings" if they try to sell those loans, she says.
A troubled debt restructuring occurs when a lender makes a concession to a struggling borrower by reducing the interest rate or giving a payment extension or forbearance to make a mortgage affordable. Restructuring a loan allows banks to avoid charging it off.
But restructured loans carry a stigma and a cost. Most analysts classify all TDRs as non-performers because the loans often become delinquent again.
Most of the loans Regions is selling are jumbo or adjustable rate mortgages that were held on the bank's balance sheet because they did not fit the underwriting criteria required for them to be sold to Fannie Mae or Freddie Mac, says Evelyn Mitchell, a Regions spokeswoman. The majority were originated before 2007 and 40% of them are located in Florida.
"They're not good loans but they're not bad loans and there is an impact against capital because you have to hold more capital against them," she says.
Accounting rules require that banks mark loans down to fair value when they are designated for sale. Regions' $75 million fourth-quarter charge came on top of a $75 million reserve already held against the loans. The combined 22% discount to the face value of $686 million says was larger than expected, Sahu says.
The ultimate loss for Regions will be only determined once the sale is completed, which is expected in the first quarter.
"TDRs are not improving significantly and for some institutions are increasing," Sahu says. "Unemployment is still high and the economy is recovering, so banks are still modifying loans and creating new TDRs. That keeps banks from making improvements in their overall nonperforming assets."
Banks' holdings of restructured residential mortgages fell 4% from a year earlier to $100.7 billion in the third quarter, but were up 300% from the precrisis levels in 2006, according to the FDIC's most recent quarterly banking profile.
The percentage of loans being restructured continues to rise and made up nearly 24% of the $426.7 billion in noncurrent loans and leases on bank balance sheets in the third quarter, according to the FDIC. The vast majority are held by banks with assets above $10 billion.
Banks are delaying the inevitable, says Jon Winick, the president of Clark Street Capital, a Chicago bank advisor that works with distressed assets. The number of restructured loans belies the current narrative of bank executives who claim their institutions have recovered from the mortgage crisis, he says.
"The composition of problem assets has certainly improved as there's a greater percentage of performing and paying borrowers," Winick says. "Regulators have been cautious about forcing the liquidation of problem assets in order to not make the problem worse."
Banks have varied widely in how they account for loan modifications and restructurings; disclosures about troubled loans are minimal, making it difficult to assess the credit quality of billions of dollars in performing TDRs and nonperforming loans.
On the bright side for Regions, the bank may be ahead of its peers in trying to sell troubled loans.
Though $12 billion in nonperforming loans were sold last year, the vast majority were unloaded by the Department of Housing and Urban Development, says Kingsley Greenland, president and CEO of DebtX, which operates an online market for loan sales. There have been few sales of residential TDRs partly because banks prefer to avoid taking losses on a sale, so they keep holding the loans.
The real question is whether banks have set aside enough reserves to cover potential losses, says Bill Moreland, the founder of BankRegData.com.
"Banks were at one point putting gobs of reserves in and now they're taking gobs out," Moreland says. "Regions would not have had to take the provision if they were properly reserved."
Mitchell, the Regions spokeswoman, called that interpretation "incorrect and misleading," because accounting rules do not allow banks to reserve against fair value changes on loans held for investment.
Banks have been "putting out the spin" that they're lending again and have recovered from the mortgage crisis, says Winick, but they are still sitting on large numbers of bad assets.
"If they're not selling loans, it's bad for the economy because it's interfering with the natural recovery of the market," he says.