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NEW YORK, Jan 27 (Reuters) - Commercial real estate losses could erode capital at U.S. banks, and ongoing government support may be necessary, especially if the economy worsens, Standard & Poor's said on Wednesday.
"We also believe that the combination of elevated credit costs, higher capital requirements, and weak earnings could result in additional bank downgrades in 2010," the rating agency said in a report.
Banks' earnings are an important source for replenishing capital worn away by credit losses. However, the mortgage and investment banking revenues that supported earnings during the first three quarters of 2009 may not be as reliable in upcoming quarters, S&P said.
New bank fees, including one proposed by President Barack Obama on Jan. 14, "have the potential to dampen bank earnings for some time," S&P said. Under Obama's proposal, which would be levied on firms with more than $50 billion in assets, banks would have to pay up to $117 billion to reimburse taxpayers for the financial bailout.
With banks vulnerable to economic trends, "we are concerned about the potential lack of a political and regulatory road map," S&P said. "Moreover, we believe that future assistance, of the type that just played a large role in stabilizing the financial system, might be difficult--if not impossible--to marshal in the future."
About $16 trillion in government aid helped stabilize the financial system during the credit crisis, but future stability will hinge on economic recovery and the capital markets' willingness to extend credit once the government steps out, the rating agency said.
Legislative proposals will support the trend toward more risk-averse banks, but the transition will not be easy, as higher capital and liquidity requirements put a burden on some banks, the rating agency said.
S&P said it expects strains on the economy to decline thanks to an improving housing market, better consumer and business confidence and calmer financial markets. Still, the economic recovery will likely be subpar, resembling a "lazy U." the agency said.
If that baseline scenario proves out and the credit cycle continues to improve, banks' credit quality could stabilize by early 2011, S&P said. However, banks will continue to move toward lower leverage and greater liquidity, keeping core operating earnings lower than they were during the boom years, it said.
If the economy performs worse than expected, banks could be hit with another wave of significant write-downs, "resulting in a potentially serious threat to weaker banks' capital positions," the rating agency said.
The falling value of assets ranging from prime mortgages to commercial real estate loans "could, once again, test confidence in the banking system," S&P said.
Banks are already facing weakening credit performance of first-lien mortgage loans and home equity lines of credit and may have to write down more residential mortgage-backed securities, S&P said.
Commercial real estate credit quality also continues to deteriorate, the rating agency said.
"During 2009, this trend contributed significantly to asset-quality concerns that led us to downgrade 27 banks," S&P said. "A total of nine banks, approximately 20 percent of our rated universe, now have speculative-grade ratings" -- BB-plus or lower. (Reporting by Dena Aubin; Editing by Leslie Adler)