The recent sale of a nearly vacant mall in Kentucky serves as a good case study in unwinding troubled loan participations.
The sale of the Turfland Mall property in Lexington last month for roughly $6 million capped a two-year struggle by the borrower and more than a dozen banks to find a solution for a troubled credit.
"It takes a while to get 14 banks in six states with different regulators to get on the same page," says Jon Winick, president of Clark Street Capital, which handled the loan sale.
"A few of the banks were constrained, some were under consent orders, others were really tiny banks," he says. "Overall, very few banks are carrying their nonperforming assets at what they are worth."
The proposition, as Winick describes it, was to market the loan wholly with a belief that doing so would create more value than holding it, foreclosing or having the individual banks sell their stakes. The loan was originated in 2006 at $16 million. The balance was $14.8 million at the time of the sale.
The sale of nonperforming loans often divides bankers because of the discount involved. Some view such sales as a clean solution and a way to move on. Others prefer to hold out for a better return. Bank investors tend to like loan sales — especially bulk sales — despite the discount. Several banks have held successful capital raises that they paired with big loan sales.
There is no way to determine how much of the nearly $300 billion of nonperforming assets that banks held at Sept. 30 involve participations, but Winick says they are harder to resolve than a wholly held loan and could be an impediment to recapitalizations and bank consolidation.
"Every single M&A transaction is predicated on an agreement on the marks on the legacy portfolio," Winick says. "It becomes harder when the [selling] banks have limited control in a nonperforming loan."
The biggest issue for getting the lenders on the same page with the Kentucky loan was the participation agreement, Winick says. The agreement did not specify how many of the participating banks needed to approve a sale in the case of default.
Piper Jaffray originated and serviced the loan, though the company never had a stake in it. HopFed Bancorp (HFBC) in Hopkinsville, Ky., which had a large stake, eventually took the lead role on the loan. Michael Foley, HopFed's chief credit officer, brought the participating banks together, Winick says.
Foley did not immediately return a call for comment.
The recent loan sale is not only a good lesson in resolution. It also should serve as a cautionary tale to banks that are looking to structure similar credits.
"The rules of the road should be pretty clear," says Steve Brown, chief executive of Pacific Coast Bankers Bank. "We standardized our participation documents two years ago and have them reviewed often to bring in the best practices."
Loan participations have caused some heartburn for growth hungry banks in recent years, but they remain a good way for banks to diversify and increase the size of their portfolios, says Bob Shober, a senior consultant at Professional Bank Services, a bank advisory firm in Louisville, Ky.
"I don't want to discourage banks from doing participations," Shober says. "They are a good vehicle to spread capital and risk around. My advice is to know your lead lender when you do one."