With investors eager to buy loans, bankers are taking advantage of the liquidity to keep their portfolios lean and clean.
Problem credits, in particular, are being sold as bankers weigh the price they can get in the secondary market against the time and expense of collection. And while subprime consumer loans have grabbed the headlines, banks also are shedding distressed loans from their commercial loan portfolios, with transaction volumes rising even in small-business and middle-market loans.
"In the last three or four years almost every quarter we take advantage of the loan sale market," said Dale Greene, chief credit officer at Comerica Inc. in Detroit. "It almost always depends on price. Then, beyond price, a lot depends on what we think it is going to cost us to continue to work it out, and for how long.
"There is a fair amount of liquidity in the market for just about everything. That would include distressed debt," he said.
Buyers include hedge funds, private-equity firms, and individual investors.
First Financial Bancorp in Hamilton, Ohio, is another satisfied seller.
"We see it as a tool of managing credit," J. Franklin Hall, First Financial's chief financial officer, said in an interview last week. "What we try to balance is the price versus the internal resources we'll have to dedicate to work a credit out. If the market values something at 95 cents at the dollar, and we think we can achieve 95 cents on the dollar, but it takes us two years to get there, then it makes more sense for us to sell it."
His $3.3 billion-asset company sold $53 million of problem commercial loans last year and the rest of its portfolio, worth $15 million, in March.
"Demand is strong and getting stronger from the buyers," Mr. Hall said. "Four years ago I might have received two or three phone calls a year from direct debt buyers. It's easily two or three a month now. There is just a lot of liquidity chasing assets. It is my sense that demand is increasing, which is great for the sale side.
"It has been received very positively by all or our constituency, including regulators," he said.
Kathy Dick, deputy comptroller for credit and market risk at the Office of the Comptroller of the Currency, is not taking sides, but she said the demand for loans can turn the lending process on its head.
"They are not originating facilities because of the relationship with the borrower — they are originating them because an investor is interested in buying," she said. "They don't keep the credit risk, but they need to recognize the reputation risk associated with underwriting the credit."
Exactly how many loans are changing hands is hard to say, because the full extent of these transactions are rarely disclosed, and not all loan sales use brokers and investment bankers.
William F. Looney, an executive vice president of U.S. loan sales at Debt Exchange Inc. of Boston, said that in the first quarter his firm's distressed commercial loan sales increased about 25% from a year earlier. He would not provide specific figures.
Sean McVity, a managing director at Garnet Capital Advisors LLC of New York, said there has been "a modest increase during the course of 2007." He also said that the growing willingness of bankers to sell distressed loans is part of an ongoing trend.
"The real trend started five years ago," when bankers decided that loan sales can be more profitable than keeping them, he said.
Mr. Looney agreed that selling loans can help banks manage their liquidity. "The sales are generally speaking at full market value," he said. "In fact, given where the market is right now, oftentimes banks are getting much higher numbers than they may have the assets on the books for."
The trend is also being driven by the more systematic approach that large banking companies are applying to portfolio management. New management techniques and programs make it easier to determine which loans should remain on the books.
"That accounted for a lot of the volume in the market," because more credit officers decided to sell rather than to work problem loans out themselves, Mr. McVity said.
Mr. Looney and Michael F. MacDonald, a managing director of loan portfolio sales at KBW Inc.'s Keefe, Bruyette & Woods Inc., agreed that bankers' attitudes toward working out bad credit have contributed to the increasing number of problem-loan sales.
"The larger banks have better resources," particularly a group of employees to work with customers to resolve the problem, or they can find buyers for the collateral to keep nonperforming assets at a desired level, Mr. MacDonald said.
And for the small banks lacking that kind of expertise, "it becomes more imperative to seek a solution to their issues through a sale," he said.
Bankers also are turning to sales to please both Wall Street and the regulators, neither of whom take kindly to rising volumes of problem loans.
"There has been more external pressure over the last six to eight months to move them towards the decision to not work the loans out and put the up for sale," Mr. MacDonald said.
In the first quarter he said his firm sold $110 million of distressed small-business and middle-market loans. In the previous two years it had no distressed commercial loan sales in the first quarter.
"Generally, people try to clean up their balance sheet for yearend. It was an unprecedentedly high volume for a first quarter," Mr. MacDonald said. "I anticipate it will be a pretty busy year," as bankers "take advantage of the strong pricing."
Keefe Bruyette's sales to date have split roughly evenly between performing loans and distressed assets, he said. "Over the course of the last six months, we were seeing more and more business on the distressed side. I think it will be 60% to 75% in the next couple of years."
Sharon Haas, a managing director of Fitch Inc., said the trend toward selling loans, particularly shaky ones that are still performing, can benefit banks. "It's one of the reasons why credit quality has remained so good."
But Ms. Dick said the volume of problem loans is being held artificially low by bankers who loosened underwriting standards on the front end and now are cutting borrowers a break.
"There are reasons the nonperforming numbers look as good as they do, and as we've been reporting through our underwriting survey for the last two years, underwriting standards are easing. Tenors are extended, covenants are waived, [and] repayment is generously provided on some of these facilities," she said. "It is going to take a lot longer for true nonperformers to show up. … This is a real issue in the retail and commercial space."
Observers do not expect loan sales to slow if credit quality continues its gradual decline.
"We don't see liquidity drying up," Mr. Looney said.
According to Mr. MacDonald, a sudden shock to the economy, and a subsequent dramatic deterioration in credit, would cool the market quickly, but a slow deterioration would not make sales difficult.
Ms. Dick added a caveat.
"The hedge funds are the ones with the greatest risk appetite," she said. "From what we've seen, they don't leave these markets. Things will reprice, and deals will shake out, but those investors like higher-risk assets." Still, "we're in a place we haven't been before, so there is a lot of uncertainty about how the market will react to various events."
