California, Florida banks may soon cross shadow line

By Sweta Singh and Bhaswati Mukhopadhyay - Analysis

BANGALORE (Reuters) - With U.S. housing markets showing signs of recovery, the worst may well be behind for small and medium-sized banks in Florida and California, two of the states hit most by the housing slump.

Pending sales of previously owned U.S. homes shot up by 6.7 percent in April, the biggest monthly gain in 7- years, a positive sign for a sector at the root of the global economic meltdown.

"I think there is a growing body of evidence that the housing market has now hit bottom and is no longer really deteriorating. We should begin to see a recovery in home sales and prices in second half of this year," Bernard Baumohl, chief global economist at the Economic Outlook Group, told Reuters.

Banks, such as BankAtlantic Bancorp Inc (BBX.N), Seacoast Banking Corp of Florida (SBCF.O), Preferred Bank (PFBC.O) and Nara Bancorp Inc (NARA.O), in Florida and California have seen their margins come under pressure and asset quality deteriorate amid rising defaults.

The two states together have seen six banks fail since January.

Improvement in real estate will enhance the value of the collateral in these states and banks will have to write off less on their balance sheets, setting the stage for recovery, Baumohl said.

"I think we are at an early stage of that process now," Baumohl said.

Although industry experts see the downturn in commercial real estate as still in its early stages, they believe home price declines are starting to bottom out and expect banks in these states to see some rebound in business activity toward the end of 2009 or early 2010.

"You are seeing better loan pricing, the cost of deposits has come down for the industry, so that is a positive in terms of core earnings power," analyst Lana Chan of BMO Capital Markets said.

Margin pressure may ease in the second half of this year, said Chan, who has an "outperform" rating on the sector.

For the housing markets from Florida to California, which suffered price drops of 50 percent or more from their peak, there may be a bottom within sight in the fourth quarter, according to a report from Moody's Economy.com.

Analyst Matt Olney of Stephens Inc said he does not see an immediate recovery, but he believes 2010 will be better than 2009.

Federal Reserve actions to increase liquidity will also make it easier for the banks to replenish their lending funds, Lawrence White, an economics professor at New York University's Stern School of Business, said.

Analysts, however, said non-performing assets of these banks may continue to rise in 2010 as the focus shifts from residential construction to commercial real estate and commercial business lending.

MERGER RULES