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While many industry insiders believe that the sale of “legacy loans” by banks is necessary to further stimulate liquidity, no one has a crystal ball to the ultimate outcome of this financial crisis. As often happens, history tends to repeat itself and some of the lessons learned from the banking and S&L crisis can be applied today. While the problems are not identical to our current predicament, enough similarities exist to enable us to draw some meaningful conclusions. But, first let me say that the concept of banks selling devalued loans or other troubled assets is not new and can be a great tool to help these financial institutions clean up their balance sheets.

In the period between 1980 and 1994, nearly 3,000 banks and savings and loan institutions either failed or required government assistance resulting in the combined total of $924 billion in assets. This was the equivalent to $168 million in loan assets that had to be resolved each day for the 15-year period. Many of these institutions were exceptionally large and were concentrated in deteriorating markets.

The FDIC had record levels of devalued loans and other troubled assets to manage and dwindling insurance reserves. Through the ingenuity of the FDIC and Resolution Trust Corporation (RTC) the concept of loan sales and other initiatives were created to resolve the fallout of the crisis. New businesses were born and others grew as these assets were returned to the private sector. This caused the formation of a new industry that has developed over 20 years into an efficient marketplace.

What the banking industry learned from those times was that there is typically a time lag from the onset of an economic downturn and when it makes sense for banks to employ loan sales as a part of their overall risk-management strategy to maximize the value of non-performing loans. For certain types of financial instruments, such as residential and commercial construction loans, the prices that banks are expecting have remained far higher than investors are willing to pay. Recently, some of the larger banking institutions have been able to raise capital. So the combination of raising much needed capital and a gap in perceived value versus obtainable value has delayed the sale of some distressed debt.

However, if banks continue to experience deterioration of their loan portfolios – as many industry experts predict – the sale of these less liquid assets will be as necessary as it was during previous credit crises.

Prudent bankers have leveraged loan sales to clean up their balance sheets and effectively reduce non-performing loans for a long time. These sales provide a streamlined process to move a large number of “legacy loans” off the bank’s books generating capital and freeing up human resources to focus on more profitable activities.

Additionally, in good economic times financial institutions use loans sales to manage future risk and refine loan portfolio mix.

While the challenges moving forward are many and vary from bank to bank and region to region, I believe that both certain governmental agencies and the private sector have, and will continue to take the appropriate measures to assist troubled institutions. By fully understanding the lessons we’ve learned from past financial crises we can apply some of these solid recovery principles so that credit markets will begin to flow again.

Bliss A. Morris serves as president and chief executive officer of First Financial Network. Opinions are the author’s own.

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