Rising levels of nonperforming commercial loans are fostering a new cottage industry: managers of distressed commercial debt funds.
Banks have long sold portfolios of consumer debt to specialized funds. Now, facing deteriorating credit quality in their commercial loan portfolios, banks are trying to find similar creative solutions.
Wall Street bankers said they have been hearing from a growing number of banks in recent months about arranging sales of troubled commercial loan portfolios. The number of inquiries has accelerated since the third and fourth quarter, said John Urban, chief operating officer of leveraged finance at Goldman Sachs Group.
There are many banks looking at it very seriously right now, said Ken Wormser, who heads the U.S. asset securitization business at CIBC World Markets.
Pacific Century Financial Corp., the Honolulu-based holding company roiled by its exposure to a batch of troubled syndicated credits, trimmed $200 million in commitments in the third quarter. At the time, it said it planned to reduce its $1.2 billion in outstanding loans to approximately $1 billion, mostly by eliminating its exposure to borrowers that are not otherwise customers of the company.
Hibernia Corp., a New Orleans-based company reeling from rising nonperforming assets, has also moved to clear its books. In a December earnings warning, the company said it would increase its loan-loss provision to $70 million in the fourth quarter to cover $55 million in charged-off credits and $90 million in nonperforming loans. The bank said it would handle its credit issues, in part, by selling the charged-off loans.
Traders and analysts said Bank One Corp.; Bank of America Corp.; Unionbancal, which is mostly owned by Bank of Tokyo-Mitsubishi Ltd.; and Wachovia Corp. are also likely to be mulling loan sales.
FleetBoston Financial Corp. is another example. The Boston-based company said Wednesday that it has finalized the sale of $1.35 billion in commercial loans, $225 million of them nonperforming and the rest troubled but accruing.
The sale, completed on Dec. 28 to Patriarch Partners LLC of New York, also included $150 million in loan commitments that troubled borrowers have not yet tapped. The portfolio will be managed by Patriarch in a new fund set up for investors.
The typical investors in such funds are offshore insurance companies and large domestic pension funds, said Jeffrey Maillet, bank loan fund manager at John Nuveen & Co. He said more such funds are on the way. I had a long conversation with an institution this morning looking for a manager to do just that, Mr. Maillet said. He refused to identify the institution, except to say it was a Canadian bank.
Fleets transaction will reduce its nonperforming assets for the fourth quarter by 10% from third-quarter levels. Fleet said it received $725 million in cash and another $203 million in an investment-grade security.
This is what we have been trying to do for a long time, trying to strengthen our balance sheet, said Charles Gifford, Fleets president and chief operating officer. Weve been aggressively marking down loans over the last year.
But the actions will not be enough to keep Fleet from suffering in the future, Mr. Gifford said. This positions us for flexibility. But we still have some struggles ahead of us, he said in a telephone interview. The fourth quarter nonperforming assets will be down, but they will be increasing going into 2001.
Ten to 15 years ago, banks looking to offload bad loans might have created a separate institution specifically to buy them and extract as much of their value as possible from the borrowers, while the bank itself wrote them off, a tactic known as good bank/bad bank.
The Fleet deal is slightly different. Mr. Gifford described it as an arms length relationship. Traders and investment bankers said the deal is essentially a securitization, distinguished by the size of the transaction and the time it took to complete. Patriarch approached Fleet in the summer about putting a deal together, Mr. Gifford said.
Analysts said other banks may have a tougher time putting a deal together. For one thing, companies such as Bank One and Bank of America have been struggling with steadily rising nonperforming assets but have not been charging them off as aggressively as Fleet has over the last year. Charging off the loans is a prerequisite to a deal.
We dont think this is necessarily an easy way out of troubled debt for other large banks, said James Mitchell, an analyst at Putnam Lovell Securities Inc. We dont believe that most banks are in the same position as Fleet with respect to their balance sheets or with respect to aggressive writedowns on their current portfolios.
David D. Gibbons, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, said securitizing troubled loans to get them off the books is a strategy that may become more common. The capital markets have given us more flexibility in terms of financial solutions, and I wouldnt be surprised to see other institutions take advantage of them, he said.
The financial impact is probably much the same as the good-bank/bad-bank model, Mr. Gibbons said. But this is a different way of going about it.
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