The Treasury Department's Public-Private Investment Program, which the government is counting on to spark lending and kick-start the economy, may initially appeal more to banks with the financial heft to withstand writedowns on toxic loans.
Though that would not doom the program, in which banks and other investors would be able to buy and sell toxic securities and loans, it could make for a fitful start.
Chris Marinac, an analyst with FIG Partners LLC in Atlanta, said it would fail if only large, healthier banks participated. That is because weaker ones would be forced to continue carrying such assets on their books, potentially impairing their ability to raise capital. Limited participation would curtail liquidity in the nascent market. That, in turn, could impair pricing of the loans, most of which stem from consumer and commercial real estate deals.
"It's nice if SunTrust participates, but it's more meaningful if SunTrust and 20 other banks in Atlanta or Florida participate," Marinac said. "You've got to move all the way down the food chain."
Ken Zerbe, an analyst with Morgan Stanley, wrote in a research note issued last week that the banks most likely to sell loans under the program have already written down many of their toxic assets and have significant capital reserves, which provide a buffer against further losses.
"We believe the banks that have recognized the largest writedowns will be the most willing to accept the prices emerging from the auction process," Zerbe wrote.
He identified East West Bancorp Inc. in Pasadena, Calif., First Horizon National Corp. in Memphis, Marshall & Ilsley Corp. in Milwaukee, South Financial Group in Greenville, S.C., and Synovus Financial Corp. in Columbus, Ga., as companies that may choose to sell loans under the program.
Most of these companies have written down bad loans or marked them as "held for sale," Zerbe wrote.
For example, Marshall & Ilsley wrote down $55.6 million of loans on foreclosed properties last year, compared with just $1.3 million in 2007. Synovus transferred about $73 million of impaired loans to held-for-sale status last year, booking a related writedown of $3.2 million.
In an analysis of the loan portfolios of 29 banking companies from 2007 and 2008, Marinac cited Citigroup Inc., which has charged off 59% of its problem loans, as a good candidate to use the program.
Others include Irwin Financial Corp. of Columbus, Ind., which has charged off roughly 67% of its troubled loans in recent quarters, and Capital One Financial Corp. of McLean, Va., which has charged off 65%.
"The guys who are in a better position to do this are the guys who have already taken their loss" on nonperforming, past due or delinquent loans, Marinac said. "If you are going to participate in these programs, you have to have already taken big losses, and you have to have the capacity" to accept additional hits.
By contrast, analysts said institutions with weak near-term balance sheets may shrink from unloading troubled loans, especially if that requires swallowing a loss that could hurt their capital ratios.
"Maybe weaker or less-capitalized banks are interested, but if selling loans at a loss means too much thinning out of their capital ratios, they just might not do it," said Maclovio Pina, an equity analyst with Morningstar Inc. "They might not be profitable for some quarters, but they cannot afford to be insolvent."
Analysts expect most banks to use the program initially to sell weak securities, rather than loans.
"I think it is going to be very slow-moving on the loan-sale side," said Anthony Polini, an analyst with Raymond James Financial Inc. "The secondary market is frozen, and there are wide spreads between the bids and the asks on those loans."
David George, an analyst with Robert W. Baird & Co., wrote in a research note last week that most banks have already marked their securities portfolios down to market prices, so they are easier to sell. Securities are "likely closer to a realistic clearing price rather than loans."
The importance of getting this program out of the gate quickly is not lost on government officials or federal regulators. President Obama met Friday with a number of banking chief executives, including JPMorgan Chase & Co.'s James Dimon, Citi's Vikram Pandit and Bank of America Corp.'s Kenneth Lewis, in a show of support for the industry.
In addition, Federal Deposit Insurance Corp. Chairman Sheila Bair told bankers in a conference call last week that her agency is open to letting banks that have sold loans into the program take a stake in the funds that acquire these assets, which would offer a payoff should those loans appreciate in value.
"It's critical that the FDIC permit banks to share in the upside," Marinac said.
Pina also said a slow start would not necessarily sink the program. If bankers "see that things are moving, they might be inclined to join in."