Toxic Loans, More Toxic Problems

Posted by Ray on August 14, 2009 under Economy, Main, Markets | Be the First to Comment

It will be interesting to see what banks get shuttered tonight with the news of the Colonial and BB&T deal. We will count the Colonial as a failed bank early and will post the details about it later, as in the potential cost the FDIC, etc. The main problem will more than likely be the so called ‘hot money’ or broker sold CD’s combined with riskier loans and defaults, we are working on a detailed post about this very issue. However, Bloomberg had an article today about problem loans reaching 5% of capital for banks, which can pose major problems or failures.

This comes on the heels of the FASB report yesterday which may force banks to price loans to market which will clearly exacerbate this very problem. However, what Bloomberg had to report was my greatest concern about banks and their solvency or lack thereof. According to the article there are 150 publicly trading banks that have reached the 5% level of nonperforming loans, defaulted loans, and a total of 305 banks on the FDIC’s troubled institution list which have bad loans at 3% of capital already.

This is a major problem and will continue to squeeze consumer credit lower as these small banks are shuttered by the Feds. Not to mention the cost to the FDIC and other institutions either holding their debt or who have lent money to these institutions. With this whole too big to fail nonsense these smaller institutions have been left behind to wither and die on the vine. Even though these failures will be less problematic to the financial system it is still a problem for smaller towns where these banks operate and, frankly, an embarrassment considering all of the money we have thrown at the problem.

I believe that this situation is also a major problem with regional banks that hold a lot of commercial real estate and residential mortgages. The greatest amount of this 5% bad loan threshold is within these regional banks. While the vast majority of the institutions are currently at only 3% of bad loans it is safe to assume that number can jump if the economy slips further, which it more than likely will. Here is what Walter Mix said; “At a 3 percent level, I’d be concerned that there’s some underlying issue, and if they’re at 5 percent, chances are regulators have them classified as being in unsafe and unsound condition,” said Walter Mix, former commissioner of the California Department of Financial Institutions, and now a managing director of consulting firm LECG in Los Angeles. He wasn’t commenting on any specific banks.

The article also stated the following;

Nonperforming loans can eat into a company’s earnings and deplete cash, leaving banks below the minimum capital levels required by regulators. Three lenders with nonaccruing ratios of at least 6.2 percent as of March were closed last week. Chicago- based Corus Bankshares Inc., Austin-based Guaranty Financial Group Inc. and Colonial BancGroup Inc. in Montgomery, Alabama, each with ratios of at least 6.5 percent, said in the past month that they expect to be shut.

“This is a fairly widespread issue for the larger community banks and some regional banks across the country,” said Mix of LECG, where William Isaac, former head of the Federal Deposit Insurance Corp., is chairman of the global financial services unit.

This crisis is not over which has been our sentiment for some time now and recently confirmed by Deutsche Bank earlier this week. With this type of action in the banking system is it no wonder why consumer sentiment is down so drastically? The media has done a great job of talking down our most serious problems and think that positive equities, which priced in perfection for the economy and earnings, is indicative of an economic recovery.

Equities are the worst indicators of economic health for an example just look at the market in November of 2007, when the crisis was pretty apparent to everyone, for the most part, when the market reached its all-time high and then the rally of 2002 when things appeared all clear because of higher equity prices. Clearly equities are not forward looking and should not be used as a gauge of economic health.

This is why I have been extremely reluctant to invest in equities and greatly reduced my exposure last week and earlier this week. Now, it appears, I am vindicated about my decision as the market failed to breach its resistance on the S&P and we see a fairly sharp selloff today. I think we are closer to the end rather than the beginning of the recession, but there are so many issues that are being ignored.

Based on the Bloomberg article and the rising bank closure rate it would be insane to invest in regional banks at this time. I see no problem with buying the majors as the government owns them and they will not fail, but the smaller and regional banks are clearly on their own and they are failing. Make sure you examine the balance sheet of any bank stocks you own as it may be surprising for you to see exactly how much bad debt is still on the books.