Business Banking: FDIC admits problems in small commercial lenders

The USA is not even close to resolving the underlying mess in its banking sector. With the closures of banks in the past week bringing the total this year to 116, mostly small, banks there is nothing clever about recognising that these, the second tranche of closures after the disastrous 2007-2009 period must be lenders in a different risk.

And so they are: the banks closed in the early days of the crisis were those lending to the consumer market, particularly in ill-advised and in some cases fraudulent lending on residential property.

But lenders have a soft-spot for landlords and those that build property for rental: after all, the theory goes, if someone can't get a loan to buy a property, they'll have to rent. So landlords become a fall-back position for those whose properties are repossessed as well as those who can't get a credit rating in the first place.

More, landlords, often, charge a higher rental than the equivalent loan repayment and so, in addition to having the property as security, banks can take rental income as a form of security, too - if they structure their loans appropriately. So banks see landlords as, in effect, secondary lenders at relatively low risk.

That's fine - so long as landlords can let their premises. The problem is that, in a recession, they are seeing falling occupancy, failing businesses as tenants and falling income. That translates into falling repayments. Banks, still focussed on the measure of property values, are tricked into believing that the value of a property is based on a multiple of the highest most recent letting. The fact that tenants are receiving rent holidays and rent reductions to help them stay in business (and therefore pay something and ensure that strip- and mall-owners don't end up with a chain of empty lots does not feature in the value of a landlord's "assets" so far as a bank is concerned.

Across the world, not just in the USA, landlords are seeing tenants leave at the end of leases. One major mid-range shopping mall in Kuala Lumpur has seen two "anchor" tenants leave the same premises as their favoured contracts end. One of those tenants, a UK department store, has recently taken another anchor position in a renovated mall - having been absent from KL for several years. A second, high-end, shopping mall has a high footfall but few sales: a store manager for a major international brand told ChiefOfficers.Net that she expected the store to close at the end of its concessionary period: even within that period, she said, the shop was not covering its costs.

But FDIC is putting a brave face on the position in the USA: in a little noticed speech, give in India recently, showed the reality of a picture that the US government is (as it did before the first part of this recession hit) trying to talk up. Speaking at The Reserve Bank of India in June this year, FDIC Chairman Sheila C Bair said:

"After many months of recession and job losses, the U.S. economy is beginning to recover. Though substantial uncertainties remain, we are seeing gradual progress in terms of economic activity, and even signs that payrolls are starting to expand and that bank loan performance is beginning to stabilize. But banks continue to set aside large provisions for loan losses, and bank failures continue at an elevated pace.

"While some of the early bank failures in this crisis included large mortgage lenders that offered risky loan products, U.S. bank regulators are now dealing with problems among smaller community banks with high concentrations of construction and commercial real estate loans. Still, during the past year we have seen some welcome signs of stability in many housing markets. Inventories of vacant homes are beginning to shrink, existing home sales are up, and investors have been buying distressed properties even in troubled markets.[cut]

"Federal policy initiatives, including a homebuyer tax credit and purchases of mortgage-backed bonds by the Federal Reserve, have provided important support to the stabilization of housing markets. But now that many of these programs have expired, we face some additional uncertainty about the near-term direction of home prices.

"Today, more than 11 million homeowners – or more than one in four of those with a mortgage – are underwater, owing more than their homes are worth. At the end of March, there were some 2.4 million U.S. mortgages in the process of foreclosure, and almost three and a half million more were at least 60 days past due."

The comments in italics are those to which specific attention should be paid. There are 5 million homeloans where the property has not yet been put in the market as a distressed sale even though the loans are now so far in arrear that they are officially classed as bad or doubtful.

But note, too, that the "construction and real estate" loans include those in the retail, housing, sector. So FDIC is still focussed on that part of the industry - with the problems in the commercial property sector still being a relatively small part of its focus.

The farming, small industry, retail premises and office space sectors are all in the financial difficulty I warned of long ago. They are waiting to come and bite the recovery in the backside as regulators - and governments - continue to focus on what they have noticed and fail to look at the wider picture.

Note, too, that that was in June. Much of the "good news" Bair had to underpin her position was transient: the new jobs were short term jobs, many of which have now ended.

But Bair made a further, telling, comment which underlines just why the 116 failures in mostly small banks is so important - and why the failure of the government to properly ensure the distribution of e.g. TARP money is such a disaster in the making:

"Small banks, with assets of less than 1,000 million dollars, hold just 11 percent of U.S. banking industry assets, but are responsible for 38 percent of the banking industry's small business lending. And small businesses, those with fewer than 500 employees, are responsible for the creation of about two-thirds of net new jobs in our economy. In short, small state-chartered institutions are essential sources of credit and other services to the most dynamic, entrepreneurial portion of the U.S. economy."

Oops.