Elizabeth Warren on the Troubled Smaller Banks

by: John M. Mason

For over nine months I have been expressing my views about the problems being faced by many of the small domestically chartered banks in the United States. Very little has been forthcoming from public officials about the problems of these smaller financial institutions. Well, yesterday, Elizabeth Warren, the Chair of the Congressional Oversight Panel, in testimony given to the U. S. Senate Committee on Finance, provided us with a little insight into what government officials are working with.

Here are some of her written comments:

“The Panel’s most recent report analyzed the participation of small banks in the CPP (the Capital Purchase Program of the Troubles Asset Relief Program--TARP). Under the program, Treasury put money into 707 banks. The Panel found the experience of small banks differed substantially from that of the nation’s largest financial institutions. Seventeen of the 19 U.S. banks and bank holding companies, with assets totaling more than $100 billion, received the majority of funds (81 percent), most getting their money within weeks of the announcement of the program. Now 76 percent have repaid their TARP funds and returned to profitability.

On the other hand, small banks entered the program more slowly, and ultimately most—about 90 percent—stayed out of TARP altogether. Notwithstanding the fact that those small banks that received TARP funds were required to prove their financial health, fewer than 10 percent have managed to repay their TARP obligations, and 15 percent have failed to pay at least one of their outstanding dividends. Their problems are substantial. Small banks face serious difficulties with the coming wave of commercial real estate loans resets. Moreover, small banks do not have the same access to the capital that larger banks have, and investors know that these regional and local banks are not too big to fail. Worse yet, if they cannot exit from TARP in the next few years, they face a TARP dividend that will increase sharply from 5 to 9 percent.

TARP gets its name from the so-called “troubled assets” that were weighing down the balance sheets of the nation’s financial institutions. The meltdown in the subprime mortgage market—and the eventual spillover effects into the prime and alt-A mortgage markets—saddled banks with assets composed of or derived from residential mortgages. These securities became difficult to price and hard to sell. Nearly one year after the passage of TARP, the Panel reported that these same assets continued to impair bank balance sheets. Today, some of these same assets continue to encumber the balance sheets of many banks—especially smaller banks that are also heavily exposed to commercial real estate assets, as the Panel identified in our most recent report. So long as the residential housing market remains weak and homeowners continue to default on their mortgages and fall into foreclosure, these troubled assets will continue to pose challenges for financial institutions.”

In verbal testimony, Ms. Warren provided a number: the number was 3,000. She stated that 3,000 small banks faced serious problems in the future related to the residential housing market and the “wave of commercial real estate loan resets” forthcoming in the future.

I presume that this does not include the almost 800 commercial banks that were on the FDIC’s list of problem banks as of March 31, 2010 since these banks are already “problems.”

If her number is added to the number of banks on the FDIC’s list then we have close to one-half of the domestically chartered banks in the United States facing the substantial “challenges for financial institutions.”

One-half of the banks in the United States are facing “serious difficulties” and that ”investors know that these regional and local banks are not too big to fail.”

No wonder that the Federal Reserve is keeping its target interest rate close to zero and expects to keep the rate at this level for an “extended time.” Again, expectations are for this target rate to stay near zero into the third quarter of 2010, a period that goes beyond when most of these large commercial loans are supposed to reset.

The real estate bubble of the 2000s will not go away. It is the gift that just keeps on giving!