On August 11, 2009 the Congressional Oversight Panel issued a report titled “The Continued Risk of Troubled Assets.”
What is a troubled asset, also known as a toxic asset? The Panel defines a troubled asset as “a loan or security whose original credit risk assumptions have come into question.” In basic terms, this means the credit risk for a loan on the books of a bank has increased, so the value of the loan to the bank has decreased. The likelihood that a bank will receive the entire principal and interest for a loan has diminished, or has come into question.
In the Executive Summary of the report, the panel stated, “In the fall of 2008, the American economy was facing a crisis stemming from steep losses in the financial section, and frozen credit markets. The Treasury Secretary and Federal Reserve Board Chairman argued that a program of unprecedented scope was necessary to remove hundreds of bills of dollars in so-called toxic assets from banks’ balance sheets in order to restore the flow of credit.”
However, because of the deterioration of the situation and the problem of valuing and selling the “toxic assets” the Treasury Secretary (Henry Paulson) and Fed Chairman (Ben Bernanke) decided a quicker methodology to get the credit markets lubricated was to infuse capital directly into large banks to offset the impact of the troubled assets. The Troubled Asset Relief Program (TARP) gave banks breathing room by allowing them to build up loss reserves against future write-downs and increasing equity reserves.
But, “Ten months after its creation, TARP has not yet been used to purchase troubled assets from banks.” As just noted, Treasury’s methodology to make direct capital infusions has stabilized the financial system to some degree, however, “It is likely that an overwhelming portion of troubled assets from October, 2008 remain on bank balance sheets today.”
What does this mean for Minnesota banks? First, since no TARP funds were made available for small banks, and Minnesota has a great deal of small community banks (3rd most in the nation) the problem of troubled assets is especially serious. Small banks have a greater concentration of commercial real estate loans and mortgage loans than do large banks, which pose a potential threat of high defaults. As Federal Bank regulators require small banks to increase their loan loss reserves for this threat, this loss absorbs small banks’ equity reserves. The loss of equity means that these same stressed small banks have to enter difficult capital markets to raise investment capital. If they fail to raise the capital required by bank regulators to a safe level, they are taken over by the Federal Deposit Insurance Corporation (FDIC), and become a failed bank.
According to the Report, “We are not 10 months into TARP, and troubled assets remain a substantial danger to the financial system. Treasury has taken aggressive action to stabilize the banks…and have provided substantial protections against the repeat of 2008. Nonetheless, financial stability remains at risk, if the underlying problem of troubled assets remains unresolved.”
My assessment of this statement is that there is increased pressure on Minnesota’s small banks to rid themselves of distressed assets or raise equity capital. Additionally, it may take several years to clear banks’ balance sheets of assets that are troubled in nature and, thus, reduce the economic and failure risk that such assets portend.
Coldwell Banker Commercial Griffin Companies is poised to assist banks, regardless of size, in managing, operating, leasing and disposing of its toxic assets.
Robert P. Bayer, MBA & CPA
Vice President – Special Asset Solutions
Coldwell Banker Commercial Griffin Companies