As more community banks gravitate to a strategy of quickly purging bad loans, Saehan Bancorp in Los Angeles has something to show for holding out.
By refusing to mark down bad loans to market prices and sell them, Saehan has kept largely intact the $60.6 million of capital it raised in March. The approach also helped the Los Angeles company to cut its quarterly net loss by more than half and achieve compliance with a regulatory order.
Of course, a steady rise in nonperformers has been nibbling away at Saehan's capital cushion. And there's a long-term risk that rivals with cleaned-up balance sheets can more easily raise capital, expand their businesses and make acquisitions.
Saehan stands at one end of a spectrum of strategies for handling credit woes. Increasingly, community banks like State Bancorp Inc. in Jericho, N.Y., and TIB Financial Corp. in Naples, Fla., have chosen the other extreme: accelerating writedowns and dispositions of troubled assets.
Both methods can drain capital. The calculus depends on how much extra capital a company has and how long it thinks it can keep credit deterioration at bay.
Mark Fitzgibbon, an analyst at Sandler O'Neill & Partners LP, said the banks that are refusing to sell distressed loans for less than 50 cents on the dollar have a uniform rationale: "They are confident in the underwriting and [believe they] can eventually work these loans out at or near par value," he said. "Some banks can't afford to take that route if they have insufficient capital."
Saehan, which caters to Korean-Americans, has a 15.4% total risk-based capital ratio. That gives the company some time to address problems.
"It's a matter of getting rid of the assets … at a fair price," Daniel Kim, Saehan's chief financial officer, said in a Nov. 19 interview. "We realize that is going to take time, so we are being patient."
But with 9.6% of total assets classified as nonperforming at Sept. 30, Saehan doesn't have all the time in the world.
Kim would not disclose the discount Saehan is willing to take on nonperforming loans. He said it depends on the loan and the collateral. Saehan has taken "huge" discounts on occasion, he said.
After raising private capital, Saehan restructured its board, halving its size to six directors, including four newcomers. Three of the additions represent Saehan's new investors.
Chung Hoon Youk resigned as the chief executive in October. A request is pending with regulators to hire Dong Il Kim to the post.
The company posted a loss of $2.6 million for the third quarter, down from $7.5 million a year earlier.
Kim, the CFO, said there is much work ahead. The order disclosed in January against its $674.1 million-asset Saehan Bank, which among other things required it to raise capital levels, remains in effect. "This is a very slow process and things are getting better and better," Kim said.
State Bancorp, on the other hand, shows it's possible to cleanse the balance sheet without necessarily burning capital.
Last year it raised $11 million as part of a debt-reduction plan. It also sold some problem assets, including $20 million of loans. All told, State Bancorp reduced nonperforming loans by 74% from a year earlier at Sept. 30, to $9.1 million.
Yet State Bancorp has added other assets, and the company's tangible common equity ratio has been virtually flat; it was 7.11% on Sept. 30, compared with 7.10% on March 31. Fitzgibbon said State Bancorp's strategy had been more of an "exception as opposed to the norm," but now an increasing number of banks are migrating from the holdout camp to the mark-down-and-sell category.
"Broadly speaking, neither strategy is more correct or less correct," said Julianna Balicka, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. But she said the banks that sell bad assets early should be positioned to make acquisitions and grow.
Consider the $1.7 billion-asset TIB Financial. North American Financial Holdings infused $175 million into TIB on Sept. 30 and immediately marked the balance sheet to fair value. This led to a steep third-quarter loss, partly due to a higher loan-loss provision and a spike in foreclosure expenses. But now that the decks have been swabbed, TIB is poised to make money again.
Investors also tend to gravitate to banks that quickly mark down and sell off nonperforming assets.
"It is one thing to put money in and keep a bank from failing, but it's a whole other thing to make a return," said Dory Wiley, the president and CEO of Commerce Street Capital LLC in Dallas.
Timing is becoming critical as more banks begin to sharpen or stabilize asset quality. "When you look at what drives bank stocks up … improved asset performance is the alpha and omega," said Brett Rabatin, an analyst at Sterne, Agee & Leach Inc. For investors "looking at the banking universe and at what stock they want to own, it's not going to be with banks still facing issues."