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Firm Overview IMF Report Shows Continued Banking Weakness Caused By Real Estate Loans
August 2010
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A report issued by the International Monetary Fund (IMF) provided its assessment of the U.S. monetary crisis and related recession. This was the IMF's first assessment of the U.S. financial system, and its first of a major economy since the international financial crisis erupted two years ago.
The Obama Administration performed a so-called stress test of the 19 largest banks in early 2009. Where capital deficiencies were identified, institutions were required to either raise private capital or access public funds through TARP (the Troubled Asset Relief Program). The IMF’s report covered a larger group of the 53 largest banks in the U.S. using publicly-available data. The IMF report found serious challenges, as follows:
“There remain important risks to the U.S. financial system and its ability to support the economic recovery. Bank balance sheets remain fragile and capital buffers may still be inadequate in the face of further increases in nonperforming loans. The economy and financial system remain vulnerable to an unexpected weakening of demand, credit quality in the commercial real estate (CRE) sector, and housing prices.
The IMF analyzed three scenarios. IMF called the most optimistic scenario a “baseline”, which assumed conditions that most would considers an optimistic economic recovery. Under this scenario, economic growth will be 3.1% in 2010, and around 2.5% economic growth in the next four years. With these baseline economic assumptions, 16 of the 53 banks would need to raise $40.5 billion in the next four years to maintain a capital ratio of 6% through 2014. The 6% threshold is an amount which is minimally expected under regulatory capital ratios.
The second scenario was labeled an “adverse” scenario, but the assumptions in this scenario are actually still pretty optimistic. This scenario assumed full-year 2010 growth of 2.3%, 0.8% in 2011, and 2.6% for the next two years. Under this assumption, there will be a $76.3 billion capital deficit for the 53 banks tested.
Here are IMF’s conclusions from these two scenarios:
“…some institutions may still face strains even under a baseline macroeconomic scenario, given the lagged effects of the economic downturn on credit quality, regulatory demands for higher capital, and the continuing adjustment to more sustainable levels of leverage. And even a modestly adverse scenario could leave important parts of the system—especially the regional and smaller banks—facing further difficulties. “
The IMF conclusion is consistent with the FDIC’s conclusions. In a May 2010 report, the FDIC stated:
“The number of institutions on the FDIC's "Problem List" rose to 775, up from 702 at the end of 2009. In addition, the total assets of "problem" institutions increased during the quarter from $403 billion to $431 billion. These levels are the highest since June 30, 1993, when the number and assets of "problem" institutions totaled 793 and $467 billion, respectively, but the increase in the number of problem banks was the smallest in four quarters. Forty-one institutions failed during the first quarter [of 2010].”
As a point of comparison, the number of FDIC “problem institutions” from 2001 through 2007 was generally under 100 annually.
The underlying issues pertain primarily to real estate lending. The IMF report labeled each of the following risks as being “high”:
“Given the employment situation, which tends to be a good indicator for CRE, commercial property prices are not expected to recover soon. Around $1.4 trillion of CRE loans are expected to mature by 2014, and almost half of these are underwater or seriously delinquent. The market for commercial MBSs [mortgage backed securities] remains depressed.”
“The rising gap between the volume of delinquent mortgages and the number of foreclosures suggests an overhang of homes still to be placed on the market. “Strategic defaults” by underwater but performing mortgage borrowers are on the increase.”
According to statistics compiled by the Federal Reserve, the delinquency rate for commercial real estate loans has been, and remains at a bit less than nine percent since the third quarter of 2009 (8.6% as of the first quarter of 2010). Before 2008, commercial real estate delinquencies were well less than half of the current rate.
Poor real estate lending results and the related need for more capital explains the continuing inability of smaller businesses to obtain credit. Check your potential lender’s exposure to commercial real estate lending, and you will get advanced word on how your loan application will fare. Distressed commercial real estate loans continue to choke many banks' balance sheets. As the IMF describes, poor performance in this area will force numerous U.S. banks to raise more capital, or even cause them to fail.
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