Community Banks Face Deleveraging or Failure

Includes: KBE, KME
by: Richard Suttmeier
Bank Failure Friday Scorecard – The glut of unfinished real estate projects funded by Commercial Real Estate including Construction & Development loans has caused the wave of bank failures that began in 2008; Only 25 banks failed in 2008. 140 banks failed in 2009 with a peak of 50 in the third quarter. 157 banks failed in 2010.
  • 48 banks have failed year to date in 2011
  • 370 banks have failed since the end of 2007
  • I still predict 500 to 800 bank failures in total by the end of 2012 into 2013.
Community Banks became overexposed to C&D and CRE loans between 2003 and 2007 and these loans still clog the banking system, but the FDIC for some unknown reason has slowed the seizure of banks that should be shuddered.
  • The FDIC List of Problem Banks rose by 4 in the first quarter to 888 from 884, which is 11.7% of the 7,574 FDIC-insured financial institutions.
  • 759 of the 7,574 FDIC-Insured Financial Institutions are overexposed to Construction & Development loans.
  • Another 1,466 FDIC insured banks are overexposed to nonfarm, nonresidential real estate loans.
  • A total of 2,225 community banks are thus overexposed to CRE loans, which is 29.4% of all banks that still need to unwind risk exposures.
  • Looking at Pipeline Risk, which is the ratio of CRE loans to CRE loan commitments, 3,810 community banks have a Pipeline of 80% or higher of their real estate loans funded, which is 50.3% of all FDIC- insured financial institutions.
  • C&D loans still total $295.5 billion and including nonfarm, non-residential real estate loans CRE loans total $1.06 trillion, thus a total of $1.356 trillion in legacy problem loans remain on bank balance sheets.
Put the blame for this overexposure on the US Treasury, Federal Reserve and FDIC who ignored their own regulatory guidelines put in place at the end of 2006.
Back in the fall of 2005, the Federal Reserve, US Treasury and the Federal Deposit Insurance Corporation (FDIC) realized that community banks were loaning funds to the housing and real estate markets at a pace above what these regulators thought prudent. Guidelines were set and monitored via quarterly filings to the FDIC. These guidelines were formalized by the end of 2006. They included the following stipulations:
Overexposure to construction and development loans: The first guideline states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loan concentrations above prudent risk levels, and should have heightened risk management practices.
Overexposure to construction and development loans including loans secured by multifamily and commercial properties: If loans for construction, land development, and other land, and loans secured by multifamily and commercial property are 300% or more of total risk capital, the institution would also be considered to have a CRE concentrations above prudent levels, and should employ heightened risk management practices.
In Fed Chief Ben Bernanke’s press conference last Wednesday he recognized what I have been saying since the “Great Credit Crunch” began in March 2007 – That the housing market remains weak and that bank balance sheets need additional deleveraging.

The S&P / Case-Shiller Home Price Index – The 20-City Composite rose 0.7% in April, but down 0.1% seasonally adjusted and down 4.0% year over year. From its Mid-2006 high to its current reading the index is down 32.8%. The index began at the beginning of 2000 at 100 and a return to that level from the current reading of 138.84 would be another 28% to the downside.

(Click chart to enlarge)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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