For some unknown reason, the Bloomberg article about potential bank failures got a lot of play Friday. The only reason I can think of as to why that should be is that it was a slow news Friday. Yours truly and lots of others have been writing for sometime about the potential for lots of small bank failures.
If you haven’t seen the article just follow the link. In a nutshell, Bloomberg took a look at how many banks had nonperforming loans that exceed 5% of their assets and used that number as the determinant for their prediction that 150 more banks may fail this year.
In my opinion it’s a pretty simplistic approach to the problem. To their credit, they do point out that banks with higher amounts of equity are better able to withstand loan losses so the 5% threshold is not really that much of a determinant. As best as I can tell, though, that is how they arrived at their prediction.
Actually, just scanning published bank data looking for absolute levels of nonperforming loans is a self-deceptive exercise in the first place. Banks are noticeably slow in moving loans into nonperforming status and have all manner of ploys to keep loans out of that category. For instance, a condominium loan might be listed as current because the interest reserve account is still servicing the loan, never mind the fact that the actual building is a concrete skeleton upon which construction was halted months ago.
The methodology that Bloomberg employed is just a bit too broad for my taste. There’s a good chance that they have included banks that are well enough capitalized to withstand some relatively adverse loan losses and missed some that are likely to go down due to a lack of capital even though their loan losses might be more modest. In all likelihood, they have probably not properly determined the actual level of nonperforming loans at any given bank.
All of this is not to say that I don’t think there will be a lot of bank failures this year and next. In fact, I would put the probable number of failures at around 200 this year based purely on the number that went under during the first half of the year. As the year wears on and commercial real estate implodes more quickly, I expect the smaller banks to run out of extend and pretend room.
This is going to be expensive for the FDIC but let’s not forget that there are 8200 banks in this country. Two hundred represents 2.5% of them. That’s not a system killing number.