Distressed Outlook: Big Banks Continue to Whittle Down Legacy Loans

The nation's largest banks have attacked their delinquent loan portfolios with gusto, but they may hit barriers in 2015 as they try to further whittle down their distressed assets.

Some industry experts are predicting a new wave of delinquencies and foreclosures in the coming year if interest rates rise, causing home prices to decline.

Many of the largest banks continue to sell off nonperforming loans. Hedge funds and private-equity firms have bid up the prices of distressed loans as they seek to profit from recent home price increases, which could abate in the coming year.

Bank of America has made the greatest strides in whittling down its distressed assets after selling off more than $1 trillion in nonperforming loans since 2009. The $2.1 trillion-asset bank in Charlotte, N.C., held 221,000 delinquent loans on its balance sheet in the third quarter, a 44% drop from a year earlier.

About three-quarters of its nonperforming loans are legacy assets from its 2008 acquisition of Countrywide Financial. B of A held roughly $10 billion in nonperforming residential mortgage loans at the end of the third quarter, and $32 billion in delinquent loans inherited from Countrywide. Those totals exclude home equity loans and lines of credit.

B of A has estimated that it will get back to a normal level of delinquent loans by 2016. Some analysts think that is an optimistic assessment, since some loans probably cannot be sold, and working out problem loans — especially those at the bottom of the barrel — is notoriously slow and labor intensive.

Meanwhile, Wells Fargo held roughly $10.7 billion of loans that were 30 days or more delinquent in the third quarter, according to the bank's 3Q14 earnings. It also holds $46.4 billion in legacy loans in its Pick-a-Pay mortgage portfolio acquired from its 2008 purchase of Wachovia.

Overall, the seven largest banks and one large thrift saw an improvement in the number of seriously delinquent loans held on their balance sheets at the end of the third quarter, as of Sept. 30 according to a December report from the Office of the Comptroller of the Currency.

Roughly 5.2% or 117,673 residential mortgages were seriously delinquent at the end of the third quarter, down from 5.5% a year earlier, the report found. The reporting banks include Bank of America, J.P. Morgan Chase, Citibank, HSBC, PNC, U.S. Bank, and Wells Fargo, while OneWest Bank is the largest thrift.

But the report also noted that about 8% of mortgages held in bank portfolios lack credit scores at origination and are a mix of prime, Alt-A, and subprime mortgages.

"Since 2009, mortgages owned by the servicers have performed worse than mortgages serviced for (Fannie Mae and Freddie Mac) because of concentrations in nontraditional loans, weaker markets, and delinquent loans repurchased from investors," the OCC said.

Large bank lenders have opted to sell defaulted loans to avoid the high costs of servicing and holding the debt. Large banks in particular have relied on sales of mortgage servicing rights, as well as servicing transfers, pay-downs and payoffs to reduce their holdings of nonperforming loans. An estimated $60 billion in nonperforming loans is expected to have changed hands in 2014.