In an arrangement reminiscent of the "good-bank, bad-bank" strategy used by big banking companies, a small bank in upstate New York has teamed with a Wells Fargo & Co. subsidiary to rid itself of bad loans without having to sell them at a deep discount.

To remove $4.7 million of troubled assets from its balance sheet, Upstate National Bank in Lisbon packaged $15.2 million of good and bad commercial real estate loans and other assets and sold the pool to a subsidiary, Integrated Financial Solutions-Lisbon Asset Advisory Services. The subsidiary then sold a 68% stake in that pool to Wells' Foothill Capital Corp., an asset-based lender in Los Angeles.

Upstate National, a $138 million-asset unit of K&Z Co. LCC in Brooklyn, says it did this so that it could retain control of the assets and recover more of its investment than it would by selling the nonperforming loans at a discount or retaining them and boosting loan-loss reserves.

"Most banks would say, 'Let's sell them and get 70 cents on the dollar and be done with it,' " said Timothy McElduff, chairman and chief executive officer of Upstate. But Foothill Capital told him, "'We'll help you carry it for a couple more years while you do the right thing and try to get your money back,' " he said.

The sale, which took place last month, provided Upstate National with some of the same benefits large banks get in "good bank, bad bank" transactions, which commercial banks and regulators have used in the past to separate poorly performing assets from healthy ones.

To conduct these transactions, banks often must create separate entities to house the troubled loans and get them off their balance sheets. (Upstate National used an existing subsidiary instead.) By indirectly retaining ownership of the assets, a bank can buy time to work through the loans.

Andrea Petro, a senior vice president with Foothill Capital's financial services funding group, said this is its first transaction with a bank - the Wells Fargo unit tends to target specialty finance companies, such as factors, asset-based lenders, and equipment finance and leasing companies - but she hopes it won't be the last.

"We would like to do it with more community banks," but "this is such a unique product that most banks don't even know it's available," Ms. Petro said.

Foothill, which was formed in December, is looking to work with other small banks on similar transactions in the $10 million to $50 million range.

Mark Fitzgibbon, an analyst at Sandler O'Neill & Partners in New York, said this type of transaction is unusual, even among larger banks, because it is complicated and costly, particularly when it involves creating a separate entity to house bad loans.

Because the strategy involves so much expense and effort, it will not catch on among community banks, he said.

Still, the economy has been so good for so long that the percentage of problem assets has been fairly low, and that may help explain why there have been so few transactions of this type, Mr. Fitzgibbon said. Should the economy continue to slow, "companies with bad loans may see an increase in this kind of activity."

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