Improving prices on the secondary loan market helped large banking companies sell more problem loans in the second quarter and avoid major damage from continued deterioration in commercial credit quality.
Earnings results for the three months showed that many of the biggest banking companies were able to divest enough of their portfolios so that their balance sheets did not show a meaningful increase in bad debt. Those that were able to sell their troubled credits reported an average increase of only 1% in their problem loans. In a research report published last week, Goldman Sachs & Co. analyst Lori Appelbaum and her colleagues at the investment bank estimated that commercial banks sold more than $1.6 billion of distressed loans in the second quarter, up roughly 56% from the first quarter, when loan sales first began to pick up.
It appears the secondary market will stay healthy for the next several quarters, Ms. Appelbaum said. Prices for loans other than those to the telecommunications sector improved in the second quarter.
One reason sales of troubled commercial loans are up is that there are more investment funds to buy and manage them. Specialized investment funds have long been a market for distressed consumer debt, but a new class of buyers for these loans has sprung up as banks have continued to battle a serious decline in the health of their commercial portfolios.
Excluding loan sales, bad commercial loans at the nations largest banks actually rose 12% to 14% during the quarter, Ms. Appelbaum found. Theres a lot of liquidity for distressed loans, she said in an interview Monday. I think its helping the banks get past the problem loan cycle quicker than they may have ordinarily. This market didnt exist in the last recession.
Though banks sold a lot of loans last quarter, there were no blockbuster deals similar to FleetBoston Financial Corp.s deal, announced in early January, to sell a $1.35 billion portfolio to Patriarch Partners LLC of New York. About $225 million of the loans in that portfolio were classified as nonperforming, while the remainder was listed as troubled but accruing.
Fleet again was among the biggest sellers during the second quarter, unloading about $100 million of loans. Other large sellers included Bank of America Corp., Bank One Corp., and First Union Corp., according to the Goldman Sachs report.
Bank of America topped the list, with $500 million of loans sold. It also was a major seller during the first quarter, when it shed $300 million.
The company declined to detail its second-quarter sales, but a spokeswoman said they included one large technology credit as well as another big loan to a company in the retail apparel industry.
While loans to telecommunications companies remained a sore spot among commercial banks during the quarter (see article, page 3), Bank of America officials said the problems they have seen have not been concentrated in any other industry or region.
The slowing economy and its impact on various industries continued to have a negative impact on credit quality, James H. Hance Jr., Bank of Americas chief financial officer, said in a conference call this month.
However, the trouble does not appear to be extensive, he said. Were really not seeing any patterns or pockets of activity. What they are is companies that tend to be more leveraged than they can afford to be or whose business plans are not working.
Other industries plagued by slowdowns, bankruptcies, and other troubles include the asbestos sector, which has been hit hard by lawsuits and court settlements; auto parts; cinemas; technology; utilities, particularly those in California; and health care, according to the Goldman report.
Prices for distressed loans have risen 6.6% since the beginning of the year, according to Ms. Appelbaum. Excluding telecommunications, prices have increased about 12%, she said.
Meanwhile, most banking companies say they are trying to adjust their loan pricing to reflect the slightly higher risk.
At Bank of America, there has been an increase in relationship pricing, where it gives better prices to its long-term clients, Mr. Hance said. Were taking a different approach on that, only doing business where it makes the most sense. The days of sort of renting money cheaply are, hopefully, coming to an end.