NEW YORK (Reuters) - Bad loans clogging up bank balance sheets are fast becoming a primary target for bargain- hunting investors, as other more traditional routes for distressed investment funds have dried up this year.
Distressed investors raised billions of dollars of fresh capital after the financial crisis hit in 2007, but are showing signs of distress themselves, as fewer investment opportunities have been available this year.
“Distressed had its day in 2008 and 2009,” said Mark Dalton, managing principal of Halsey Lane Holdings, an advisory firm that assists banks in turning around distressed companies they came to own in the crisis.
“People who went out and raised new distressed debt funds in 2009 and 2010, thinking it’s going to continue, may have to be more creative, or buy equity.”
But where big bankruptcies and opportunities to buy troubled companies have fallen off, big banks are beginning to fill the void as they focus on selling off non-core loans.
“The great commercial bank sale has started,” said Victor Khosla, founder of distressed investment hedge fund Strategic Value Partners.
In the midst of the credit crisis big banks were often afraid that selling loans for fire-sale prices would put too much strain on their balance sheets, but as markets have improved and banks are seeing strength in other parts of their businesses, they have become more willing to sell the loans to investors, Khosla said.
“Banks are more and more able to afford to sell. I think we are starting a three-to-five year selling cycle,” Khosla added.
Hundreds of financial institutions are still considered “troubled” by U.S. bank regulators, and are also eyeing new capital rules which could force them to dispose of assets to raise their capital levels.
Khosla said his Connecticut-based fund has seen banks willing to sell everything from real estate and shipping loans to loans made to finance leveraged buyouts.
But only some banks are selling.
“The generally healthy banks are either getting repaid or they are increasingly willing to own it. I’m not sure they are selling things at big discounts,” Halsey Lane’s Dalton said.
So distressed investors have been focusing on banks that are willing to let go of large portfolios of bad loans, like Citigroup Inc and Royal Bank of Scotland Group Plc, which during the financial crisis both set up units to dispose of noncore loans and operations.
Over the past year Citi has found ways to sell student loans, auto loans, and Canadian credit card loans to other investors, among other assets. At the end of the second quarter Citi had about $465 billion of loans in the unit known as Citi Holdings, compared with $827 billion at its peak in the first quarter of 2008.
RBS has also been trying to cleanse its balance sheet through asset sales.
Even Bill Bartmann, the investor who made a fortune snapping up distressed loans from the wreckage of failed savings banks after the savings & loan crisis in the 1980s and 1990s has gotten back in the business of buying bad debts from the banks.
Bartmann, whose Commercial Financial Services was among the first to purchase distressed assets from the U.S. Federal Deposit Insurance Corp and Resolution Trust Co some 19 years ago, restarted a business in July to acquire bad consumer credit card debts from banks.
“This opportunity only occurs when there is a terribly bad economy,” Bartmann said.
“As the economy continues to deteriorate, the number of charged-off loans increases; and as that volume increases, the bank loses money and the bank has little or no alternative but to either collect these loans themselves — which can take an extended period of time — or sell them and reap the cash flow quickly and immediately.”
Bartmann said he has been meeting with distressed hedge fund investors to raise $100 million in equity and $400 million in debt for his CFS II funds by the end of the year and has already been able to generate 40 percent returns on $380 million of charged-off credit card debts he has purchased over the past year.
Reporting by Emily Chasan, editing by Gerald E. McCormick