If you follow the news, it seems as if we’ve turned the corner.
Congress and the President may be weighing another stimulus package to keep the ball rolling; but one look at the housing and retail numbers, and it’s easy to conclude that there are clear signs of a nascent economic recovery.
This is accurate unless you’re one of the 702 banks that the FDIC (Federal Deposit Insurance Corp.) has designated as at-risk institutions.
Last year, federal regulators shut down 140 banks amid losses brought on by the collapse of the home and commercial mortgage markets. By comparison, the FDIC seized only 28 institutions for all of 2007 and 2008 combined.
During the first seven weeks of 2010, the federal agency run by the unflappable Sheila Bair has shuttered 20 banks, the fastest rate of closures in 16 years.
At the end of the third quarter of 2009, the FDIC said 552 banks were teetering. As the fourth quarter came to a close, the number of banks on the FDIC watch list jumped by 27 percent. According to FDIC calculations, the value of the assets at risk climbed from $346 billion as of Sept. 30 to more than $402 billion on Dec. 31, 2009.
Number of Bank Failures May Soar
By virtue of the change in the law during 2009, the FDIC now insures up to $250,000 in deposits held in individual accounts. The FDIC’s deposit insurance fund, however, has a deficit of almost $20.9 billion.
The FDIC has the authority to tap into a $500 billion line of credit at the U.S. Treasury to cover losses. The agency also has raised $46 billion by requiring banks to prepay three-years of premiums into the insurance fund.
Home and property prices may be on the rise, but bank assets still are impaired. While there has been a brief respite in the number of foreclosures, particularly on the sub-prime side of the ledger, most analysts agree that it represents an abbreviated hiatus.
Industry analysts long have been projecting a steep incline in the number of option ARM (adjustable rate mortgage) loan defaults during the later half of this year spiking even higher through the middle of 2011. If these loans are not restructured or the predicted interest rate increases are modified, the FDIC’s Sheila Bair believes that the number of banks she will be compelled to close over the next two years will rise dramatically.
Although these home mortgage re-sets loom large on the FDIC radar screen, they’re only a blip compared to the projected number of commercial loans that banking and real estate experts expect to implode over the next few years.
Look Who Is Holding the Loans
Since the middle of last year, industry watchers have been predicting a second wave of foreclosures in the commercial real estate market that could further undermine our financial system and topple banks that continue to hold the paper.
Between now and the end of 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half of these loans are presently underwater – that is, the borrower owes more than the underlying property is currently worth.
More troubling still is that a disproportionate amount of these commercial loans is being held in the portfolios of small and medium-sized banks whose asset bases already are impaired.
On an aggregate national basis, the value of commercial real estate has plunged nearly 40 percent since the beginning of 2007. Falling rents and rising vacancy rates are giving commercial landlords fits.
The latest figures show that vacancy rates range from eight percent for multifamily housing to 18 percent for office buildings. Through January, rent for office space has tumbled 40 percent and is off by more than 33 percent for retail.
The immediate exposure for small and mid-sized banks over the next 18 months from failing commercial loans stretches from $250 billion on the low end to an astronomical $600 billion. If commercial real estate values keep dropping at the same pace, the liabilities of the banks under Bair’s purview could far exceed the cash her agency has to cover depositor losses.
In conjunction with the anticipated overhaul of the federal financial regulatory system being considered by the House and Senate, the FDIC may gain expanded authority to wind down systematically important non-bank financial institutions like A.I.G. But these changes will do little to address the immediate problem the FDIC is facing, covering the current bank losses.
Unless legislators, policymakers and the President act fast to either bulk up the agency’s assets, or intervene in the commercial real estate market, the added heft to the FDIC’s regulatory reach will do little to stem the tide of new bank failures.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
