- James Saft is a Reuters columnist. The opinions expressed are his own-
LONDON (Reuters) -The health of America’s banks continues to worsen, with lending to real estate developers an emerging threat and more failures in the offing.
While it is too early to say that the fire fighting on Wall Street is over, there is growing evidence that the extended fall in real estate is putting stress on Main Street as well.
Commercial banks in the U.S. face a complex and difficult situation: margins are compressed and there is increasing stress on a range of assets, from mortgages to consumer loans to debt backing commercial and residential real estate development.
For bank investors this means that we are only at the beginning of lower dividends, more dilutive capital raisings and share price falls, as well as the odd failure.
These failures aren’t likely to be widespread enough to be a systemic threat, but the capital raisings, distressed mergers and write downs that are part of the solution will further crimp lending.
This credit crunch will run and run.
It was striking just how negative top banking regulators were last week in an appearance before the Senate Banking Committee.
“We expect bank holding companies to continue to report weak earnings and further asset valuation writedowns and/or significant credit costs in coming quarters,” Federal Reserve Vice Chairman Donald Kohn told lawmakers.
“Indeed, despite higher provisioning during the past several quarters, coverage of nonperforming loans by loan loss reserves has not kept pace with growth in problem assets and bank holding companies may likely face the need to further bolster loan loss reserves.”
Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC) described how the impact is rippling out from falling real estate:
“Banks continue to experience increased pressure on earnings resulting from a deterioration in credit quality noted first in higher-risk non-traditional mortgage loans and now evident in other sectors,” she said.
“Deterioration has been particularly pronounced in construction and development lending, which is receiving enhanced scrutiny from FDIC examiners.”
Bair, whose agency both supervises banks and insures depositors, said that bank failures could hit institutions of “greater size than we have seen in the recent past.”
John Dugan, who as Comptroller of the Currency oversees national and foreign banks in the U.S., was if anything even more blunt:
”While the vast majority of national banks have the financial capacity and management skills to weather the current environment, some will not.
“Of these, some will be able to find stronger buyers - in some cases at our insistence - that will enable them to avoid failure and resolution by the Federal Deposit Insurance Corporation. In other cases, that will not be possible.”
All three officials singled out commercial real estate as an area of concern.
It makes perfect sense that commercial real estate and loans backing development would be hit during a housing crash.
Beyond the direct linkages, it is also true that places like Arizona, California and Florida, with their rows of empty foreclosed houses, are also seeing carnage in the strip malls that were built to serve those communities.
The Markit CMBX index, which tracks commercial real estate securities, has fallen thus far this year, but not as deeply as equivalent subprime indices.
The AAA CMBX is trading at about 94 cents on the dollar while the riskier BBB- index is below 70. By comparison, the main AAA ABX index of subprime is trading just above 50 and the BBB- is at 5.
These and other problems have increased the ratio of nonperforming loans at state banks to 1.57 percent of the whole, more than double the figure of a year ago and the highest rate since 1993, in the aftermath of the Savings & Loan crisis.
At FDIC insured banks loans 90 days delinquent or more rose by $53 billion in the six months to April, hitting 1.71 percent.
And while banks are growing the reserves they keep against loan losses, they are not doing it nearly fast enough.
The ratio of loan loss reserves to non-current loans fell to 89 percent in the first quarter, the lowest since, you guessed it, 1993.
So, we can probably agree that the banking industry is in a period of great stress. What is next?
Unfortunately, the difficulties in real estate seem to have a compounding effect on the way down, just as the bubble was self-reinforcing on the way up.
Just under 2.5 percent of mortgages are now in foreclosure, the most since records began the early 1970s. This is sure to pressure prices further, as lenders seek a clearing price to just get the stuff off their books.
Unemployment is rising too, which will heighten pressure on commercial and residential real estate.
Don’t be too surprised if more banks fail, and if the names become a bit more familiar.
-At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund -(Editing by Gerrard Raven)
+44 207 542 2734. Reuters Messaging: firstname.lastname@example.org