To Sell Or Not To Sell: Bankers Face Toxic Dilemma

By Matthias Rieker

MARCH 25, 2009, 5:30 P.M. ET

NEW YORK (Dow Jones)--While Wall Street is wondering who might buy banks' "toxic" loans, bankers face the dilemma of whether to sell loans at prices they feel may not reflect their real value.

Bankers have been holding onto mortgages, commercial real estate loans and other assets rather than selling them to private investors at bargain-basement prices. Holding is less painful than the hit to capital the banks would take from selling the loans.

The Treasury Department's Public-Private Investment Program, introduced Monday, might boost the price of those assets by providing leverage from the government. "This is interesting enough to at least get people on the table," one banker said.

Still, bankers' natural instinct is to hold on to their loans. "No banker wants to give up the upside" that, in a sale, would go to the buyer, another banker said. Even if full repayment is doubtful, the cash flow or the value of the collateral might be worth more than the price the bank can fetch.

The Federal Deposit Insurance Corp. has sold loans from failed banks anywhere between 4 cents and 90 cents on the dollar. Banks have sold loans at between 30 cents and 40 cents over the last 18 months - but were generally unwilling to go lower. It is unclear how much FDIC guarantees and the Treasury's leverage under the PPIP will boost pricing.

Another impediment to selling: Some bankers might not be able to afford selling at low levels because it might dangerously erode already thin tangible capital levels.

Still, there is renewed pressure on bankers to sell. The talk about "toxic" assets on Wall Street, Main Street, and in Congress has pushed bankers into a corner that makes it hard to explain that even impaired loans still retain value. Bankers - and some analysts - have complained that it is virtually impossible to reassure investors about the core banking business when banks continue to hold securities and loans broadly categorized as toxic.

Hence, some bankers might feel it is prudent to sell loans now, no matter how valuable they become longer term, particularly since the government is helping investors sweeten the deal.

The government might nudge bankers to sell, one banker said. Banks need more capital. Private investors are unlikely to invest in banks holding bad loans.

So getting rid of the loans - and hurting capital on the way - might be the way to get investors to pump fresh capital into banks with smaller, healthier balance sheets.

The benefit to selling loans, and giving up future returns, might be "a clean slate and never having that conversation" about toxic assets with investors "again," one banker said. "You could actually talk about your business."

Indeed, some analysts believe that the public is missing the point. "What is most discouraging is that the core facts of the banking industry are far more positive than anyone is willing to credit," Richard X. Bove of Rochdale Securities LLC wrote recently. Regulatory capital is solid, deposits are flowing into banks, and "loan losses are dramatically lower than anyone's conception. More than 98% of loans outstanding the banking system are paying interest and principal," he wrote.

Many analysts disagree because they assume - as do many bankers - that more commercial and consumer borrowers will become delinquent in the faltering economy.

Bankers face other challenges. "There are serious expenses to working out" a loan, and banks are unlikely to be as aggressive as loan collectors and private investors in reclaiming the principal because they want to keep the customer, said Mark Sunshine, president and chief operating officer for First Capital, a commercial finance company.

Losses and capital levels aside, bankers' decisions whether to sell or not might simply depend on their expectations about the economy. Yes, even souring loans might be worth more later and generate some cash flow in between, but how much later will the economy begin to recover?