After bankers' prolonged reluctance to sell senior loans at steep discounts to face value, a robust secondary market is beginning to take shape.
SAles of nonperforming loans should reach $3 billion this year, around three times the pace in 1990, according to BDS Securities Corp.
In part, this activity is a sign that banks are healthier today. But it also suggests that bankers are becoming acclimated to price levels far below the optimistic expectations when loans were extended, and that selling at a loss makes more sense than waiting for a return of the good old days.
Softening Standards Foreseen
Most of the laon sales so far involve large, syndicated credits for which detailed information on the company and the debt is readily available. But as a secondary market emerges, attracting more and more buyers, standards are likely to loosen.
"The only constraints are how many buyers there will be and what is their capital base," said Malcom T. Murray, executive vice president and chief credit officer at First Union Corp. First Union said it has not yet sold bad corporate loans through this secondary market.
Prices vary widely, but nonperforming loans generally fetch less than 80 cents on the dollar. Debt of five companies traded recently in a range between 32 cents and 70 cents on the dollar.
Prices Climbing Steadily
Professional debt traders said that prices have climbed roughly 10% from a year ago.
Some investors are not waiting for banks to take the first step. In the past two months, Bank South, for example, had inquiries from Dun & Bradstreet, Gellers & Co. in Chicago,
MArket value of selected companies' bank debt. Price per dollar of face valueHillsboro 70JAmes Department Stores 65JLomas Financial Corp. 65JWest Point Acquisition 58JIntegrated Resources 32J Source: R.D. Smith & Co. Inc.
and investment banking companies seeking to purchase debt.
The supply of available bad loans is finally catching up with the demand, said Michael Singer, president of BDS, formerly R.D. Smith, a New York investment bank that specializes in trading securities of financial trouble companies.
"It has become a seller's market," Mr. Singer said.
Reasons for Optimism
Even at double the current pace, however, loan sales will represent only a fraction of the nonperforming assets that are swamping banks. But to optimists, this spells enormous room for growth.
Bank loans are senior debt, which means they carry less risk to investors than subordinated debt. Yet returns can be high. For a highly securitized loan, the annual rate of return may be 15%. With more risk, returns can reach 30%, said Mr. Singer.
"There are more funds being raised to buy these credits," Mr. Singer said. "People who traditionally looked to invest in leveraged-buyouts and now looking at investing in restructurings."
Banks have several incentives for selling their bad loans, rather than restructuring them.
Pressure from Regulators
Regulators are pushing banks to clean up their balance sheets by selling these loans at depressed prices in exchange for cash.
Another factor is that profitable banks can take writeoffs on the sale of a bad loan. Increasingly, banks will consider selling a bad loan if the expected sale price is above the writedown price.
Some banks do not feel under any pressure to liquidate loan portfolios. At Society Corp. in Cleveland, for example, loan quality is high and management does not foresee the need to sell troubled assets. But Society Corp.'s nonperforming assets rose last quarter.
In addition to the economic issues, legal issues prevent banks for making sales. "there's a confidentiality issue," said Mr. Murray of First Union Corp. A bank may face a lawsuit from a borrower or even criminal charges if it sells a loan based on undisclosed information.