How Much Risk Lurks in Your Loan Portfolio?

A new, eBay-style electronic marketplace for troubled loans tries to give bankers a clear sense of what their distressed debt is worth.

Although risk analytics tools are improving in terms of estimating the potential risk of loans, one element they often lack is precise calibration -- a reasonably accurate estimate of what the loans are worth today and what a bank could sell them for if it had to lower its risk exposure or meet regulatory demands. "One thing bankers really need right now ... is pricing expectations from the buy and sell side that they can take back to their risk models and their board of directors and know the way they should be thinking about write-downs," says Mike Sheridan, CEO and president of DebtMarket, an online marketplace for buying and selling whole loan portfolios. DebtMarket, which launched in August 2009, has about 750 members, including community and regional banks, credit unions, private equity firms and hedge funds.

Community banks are feeling a lot of pressure right now from the government to begin lending again, Sheridan notes. "In some cases they have the deposits to do that, they feel comfortable beginning to lend again and they don't have a commercial real estate loan concentration," he says. "But several bank CFOs have begun to wonder, how do they not stuff their balance sheets again with bad assets while doing the thing they're meant to do, which is serve their community?" The answer, Sheridan believes, is by quickly selling those loans on a marketplace such as DebtMarket.

According to Sheridan, however, while many community banks have accumulated a disconcertingly high concentration of commercial real estate, very little trading of residential and commercial mortgages is occurring. "Over the next 18 to 24 months, half of the $3 trillion in existing commercial mortgages will need to be refinanced and probably won't qualify," he contends. "That's going to cause problems if [institutions] are not aggressive on their write-downs. We're seeing a lot of activity as people begin to test the market for loans on their balance sheet as well as debt they're originating now that they may not want to leave on their balance sheets."