March 5, 2008 3:58PM
Which Banks Could Fail?
By Elizabeth MacDonald
A growing number of banks are in trouble.
The question is, which ones? And how long will the downturn last?
It’s a debate we’ve been hammering away at on Money for Breakfast. I’ve got the names of banks you ought to take a look at, read through to the bottom.
First, don’t be fooled by the growing chorus of critics making inapt comparisons between the current US crisis and the one that plunged Japan into its “lost decade” of a fitful string of recessions that left Japan in an invertebrate state.
Some coolants are needed—analysts need to think this through, the differences are many and important. When I hear these parallels, I’m mindful of the saying, “a conclusion is where the mind comes to rest.”
The debt crisis in Japan was largely due to a reluctance to admit mistakes and subsequent foot-dragging over writing off bad loans. Japan prolonged its crisis, which lasted from the late ‘80s through the early part of this century, because it let banks keep zombie loans on the books for far too long and covered them up with disclosures that were about as transparent as a bucket of molasses.
Japan then waited to clear bank balance sheets of some $400bn in zombie loans only until 1998 to 2004. And many banks in Japan bailed each other out by buying equity stakes in other creaky banks, so executives were loathe to quickly unload stakes or write off assets (honor among thieves). Japan, too, was agonizingly slow to cut rates, waiting to ease until 1999.
The U.S.’s debt crisis is largely due to self-regarding Wall Street geeks too clever by half who financially engineered opaque securities even they could not understand, whose bosses stayed too long at the fee-flowing subprime party through 2007, even though computer screens were flashing glaring red signs starting in 2005–artificial intelligence being no match for natural foolishness.
But what’s different in the U.S. is that accounting rules are forcing much more rapid bank writedowns. Plus U.S. banks here do not have anywhere near the investments in each other as Japan’s banks did. Also the Fed is cutting interest rates more quickly and widening the discount window, too. Fed chairman Buzzsaw Ben Bernanke is well aware of failed monetary policy in Japan, (having written a paper at Princeton, “Japanese Monetary Policy: A Case of Self-induced Paralysis?”).
So what to do about a free-market free-for-all abetted by a too-loose monetary policy that blew out a massive bubble? A bubble inflated by the metaphysical certitude that house prices can defy physics and reach to Mars?
Slashing rates won’t stop a free-fall in asset prices, but they do help break up the ice in the credit markets. And a government bailout that still aids too much debt forgiveness for irresponsible borrowers and abets excess consumption is dangerously myopic.
A bailout that puts banks at risk of trying to keep alive zombie mortgages, where borrowers have handed the keys to the bankers and have scurried away, dead loan walking, is perilous as well.
Fiscal stimulus in the form of taxpayers getting their own money back as rebate checks can help keep the economy thrumming—so long as the US saves more.
Asset bubbles are fun on the way up, but the workouts are excruciating when they blow. As the pipes burst at bank after bank on Wall Street, TV screens are now jammed with rather orotund after-the-fact refereeing that should be on any right-thinking individual’s ninth nerve (see Fed vice chair Donald Kohn telling the Senate he believes more regulation would have been better, a rare admission from a Fed official).
The downturn will last until housing finds its bottom. But given the guardrails are still few in number, a bubble could derail the markets and the economy again. So look for the lessons to learn by watching the banks now at risk.
Which banks could fail, or get bought out on weakness?
First, always watch out for fat cat pay when banks are at play, a corporate governance weakness I’ve noted to you in a prior blog (“The Richie Riches of the Housing Mess”). Banks that can’t run their executive compensation properly likely can’t administer their operations well, governance analysts have noted.
For instance, Washington Mutual (WM), whose shares are down 70% in the past 52 weeks due to the subprime and credit crisis, recently tied its executive cash bonuses to earnings results that do not take into account mortgage losses and foreclosures. Bonuses are supposed to give execs incentives to perform well–not de-incentivize them, as it were. And check out this disclosure in a recent annual report from Wamu.
Wamu put on “paid administrative leave” its former chief legal officer Fay Chapman. But Wamu is keeping Chapman on as a consultant. It increased Chapman’s pay as of January 1 to $1.1mn, plus she gets a $310,000 bonus.
And Chapman still gets $2.65mn in consulting fees over a two-year period beginning July 1. That maths out to $1,325 per hour. Wamu still pays out this fee to Chapman’s husband or heirs if Chapman dies during the two-year term, the deal says.
Next, watch the action in small to mid-size banks heavy into construction lending for things like strip malls and office developments. I previewed this problem for you already in a prior blog (“What the Fed Chairman Really Said”), but there’s more.
Sheila Bair, chairman of the Federal Deposit Insurance Corp., reiterated to the Senate Banking committee that construction loans are “one of the chief risks to the banking industry,” notably small and midsize banks, with the percentage of loans that are 90 or more days past due tripling to 3.2% from a year earlier, levels not seen since the early ‘90s. Fox Business’s Liz Claman and David Asman reported to you last week that Bair sees an uptick in failures in this banking sector.
The number of banks where construction loans exceed total capital has risen from 1,179 institutions to 2,368 since 2003, according to the FDIC, as I’ve already noted.
But about 467 publicly traded community and regional banks are overexposed to construction and development loans (C&D), with $204bn in loans exceeding risk-based capital by 185% on average, says Richard Suttmeier, chief market strategist at RightSide.com.
Dallas-based Comerica (CMA) has already put aside $108mn for loan losses in the fourth quarter of 2007, largely due to its sour real estate development loans, notably in California and Michigan.
Marshall & Ilsley Corp. (MI), a Milwaukee-based bank holding company, saw its shares drop after a Goldman Sachs analyst cut his rating on its stock, due to what he said was the company’s exposure to construction loans.
RightSide.com’s Suttmeier says he’s worried about BB&T Bank, a Winston-Salem, NC bank with $128bn in assets that “continues to increase its exposure to C&D loans to $19.5bn from $19.2bn,” Suttmeier says. “BTT has a risk ratio of 182% of risk-based capital.”
Regions Bank, a Birmingham, Ala. bank with $137bn in assets, cut its exposure to C&D loans slightly to $15.5bn from $15.7bn recently, Suttmeier says. Regions has a C&D risk ratio of 122% of risk-based capital, he says.
And always watch the usual suspects in the lending and securitization arena. Citigroup (C), second to Merrill Lynch (MER) in writedown whoppers, has a panoply of credit problems, and now even the head of Dubai Investment Capital says the bank needed more cash if it is to survive.
Even the top-of-the-line outfits are hurting. Thornburg Mortgage (TMA), a jumbo lender that has had a low default rate, is struggling to meet a $270mn margin call from its creditors after asset-backed securities it was using as collateral decreased in value. Analysts have lowered their earnings estimates and ratings agencies warn the lender it is at risk of defaulting on its debts. Shares fell 17.6% to $3.56; they peaked at $28.40 a year ago.
Fremont General just got default notices from two affiliated entities that bought a total of $31.5bn of residential subprime mortgage loans from the company in March 2000, sending shares down 39%.
IndyMac (IMB) is suffering. Aside from its loan servicing and the lender’s ‘Financial Freedom’ reverse mortgage program, a recent disclosure says “all of our operating segments reported material losses in 2007,” though the company says it expects to rebound in 2008 by, get this, selling loans to Fannie and Freddie, instead of Wall Street.
Yes the implicit backing of the US taxpayer is always preferable to a casino.
March 5th, 2008 at 4:38 pm
I’ve been reading all about the major banks woes, and it makes me wonder if the cd’s I have, wouldn’t be better off in my hands than the banks. What’s up with Wells Fargo?
My money isn’t with them, but I have a sister that works for them in Minneapolis in the Mortgage Division……
March 5th, 2008 at 4:48 pm
First time I’ve read E. Macdonald’s economic insights. I like it. CWW
March 5th, 2008 at 4:58 pm
Thanks. Nice list of banks to stay away from. Merrill Lynch got some of my savings from some of its preferred stock that I had owned for many, many years. I didn’t see it coming but when I started seeing preferred go down like crazy I knew it was invovled in some way and I sold at about a 10% loss.
March 6th, 2008 at 4:00 am
Why the banks don’t deal to save loans is beyond my understanding. Why will saving bad loans lower real estate prices? And, if prices did go down, why wouldn’t banks try to save themselves first?
March 6th, 2008 at 7:19 am
Thank you for the list of banks that are having problems. It would be good to have a list of the banks that are financially stable.
March 6th, 2008 at 8:00 am
GREAT ARTICLE! ya gotta love this facet of our greedy society who want to blame government or policy for our problems when it is their SELF-FULFULLING “policies” that FUEL it. “let’s pump the markets up because i want to make 20% per year…OR…don’t put your money in stocks…REAL ESTATE will double your money…OR what inflation?…my JAGUAR didn’t cost any more this year…”
this group is also truly BRAINWASHED to believe someone is worth $400 million to run a company and/or to LEAVE it…with endless justifications of this person’s genius or qualifications. the CEO of exxon can actually say without choking it was NOT the cost of gas that attributed to such great profits???!!!…Home Depot and Mozillo look like geniuses during housing boom and BUST during its CRUSH???!!! i am sure we could BOTH go on and on….but MY comments fall on deag ears…
March 6th, 2008 at 11:05 am
Eliabeth MacDonald is not only smart but attractive. I enjoy seeing her on FOX every Saturday morning. Her insights on the economy and the market are outstanding. Does she date?
March 7th, 2008 at 1:44 pm
Matthew comments on this blog that “Why the banks don’t deal to save loans is beyond my understanding. Why will saving bad loans lower real estate prices? And, if prices did go down, why wouldn’t banks try to save themselves first?”
Well Matthew, the answer is it is completely against everything that capitalism and good business stands for. Risk versus reward and Caveat Emptor seem to be principles that just don’t fly with this newer generation of people [of which I am a member].
Why is it fair for the financially responsible of us to pay higher interest rates so that hangers-on, speculators, and idiots can get discounts since “they just can’t pay anymore” when they were the ones on the take from the beginning? Less risk=higher interest rate [from a mortgage perspective], more risk=lower interest rate [again from the mortgagee’s perspective]. You can’t have your cake and eat it too.
The Russian banking system collapsed and it took almost a decade for it to recover after the fall of Communism. Why? Because banks made bad loans and were subsequently bailed out by the government or by other banks. When there is no negative to writing bad loans, there is nothing to stop banks from going after the highest risk, highest reward option, because there IS NO NEGATIVE!!!
This madness has got to stop…has everyone forgotten that money doesn’t just grow on trees? Our economy is organic and self-correcting. Adding artificial ‘correctors’ in the form of Smiley-face stickers and “try again next time” vouchers when deadbeats don’t pay their CONTRACTUALLY OBLIGATED LOAN PAYMENTS does nothing but inflate our already poor performing dollar.
The dollar is the new Peso, and if we don’t stop coddling all of the greedy and fiscally irresponsible citizens and corporations out there [at the expense of our own economy and strength as a nation], we’re all going to be so bad off we’d wish we lived in the country of the Peso.
March 7th, 2008 at 2:09 pm
Interesting article. One thing that the writer did not take into account is the credit ratings of the lending divisions for those banks who “continue to increase … exposure to C&D.” I own stock in several banks, including BB&T, and have done a lot of research into this bank that has provided its stockholders with a positive return for the past 20 quarters, and has a minimal volume of “subprime” and “nonconforming” loans in its portfolio. They also have much higher standards for their “builders” and with a very conservative CEO, they have not overextended themselves in the market. To quote one person’s opinion based solely on isolated numbers is unprofessional and misleading. I have found that in order to make an informed decision about bank stocks, it pays to review their entire lending portfolio, including overall credit ratings, percentage of subprime loans, percentage of nonconforming loans, percentage of construction loans, broken down into residential and commercial, as well as conforming loans, and determine how all of those loans are performing over the past 2 years, with specific emphasis on the past 6 months. Just taking the amount of “exposure to C&D loans” as an isolated item to determine if a bank is going to fail is ridiculous.
March 7th, 2008 at 2:49 pm
I have been concerned even before this broke out in the news, I think the morgage companys are very greedy, and that they where taken advantaged of the public for years and there now be held accountable, come on! where was the news on this, how many lives been ruinrant because the govermnet closed there eyes deliberately!
March 7th, 2008 at 2:59 pm
We must also remember that the Federal Gov’t put regulations on the banks and mortgage companies to offer special rates/loans to “low income, immigrants and diverse cultures” to be eligible for some federal funding. They’ve contributed to the banks failing.
The Fed Gov’t told Bank of American that it had to offer (Affirmative Action) a quota to certain americans even if they couln’t afford the mortgage or have a down payment.
March 7th, 2008 at 3:25 pm
The real danger here is that so many folks have funds in banks that are not insured. For example some money market funds are actually outside accounts but presented on bank paper. Some customers mistakenly think because they made a purchse in a bank it is all safe, secure and FDIC insured. When this stuff hits the fan will the government start massive bailouts of uninsured funds?
March 10th, 2008 at 5:51 pm
I concur with the comment by Sean. I also own BBT and like Sean, did my homework. The C&D exposure is the only negative in my investment thesis. I believe BB&T will be one of the banks that survives and captures market share when other small and midsize banks fail. BB&T is the roll-up of many small community banks and very good at integrating banks. They have suspended bank roll-ups due to the high prices, but expect them to get back in this game as prices fall. If you want more information, take a look at their investor presentation on the BB&T website which includes a pie chart illustrating their diversification by property type.
Lastly, they are a very conservative lender. I would argue they have the highest lending standards of any med-size or large bank.
March 24th, 2008 at 6:47 pm
I’ve been reading the various opinions on the problems with the sub/prime loans. My assessment of the cause of the problem is the overpricing of homes. The prices have literally gone thru the roof and are unaffordable to the average American. And the average American is no longer within the income range that is used as the measure; I believe it’s about a 60,000.00 yearly income for “middle class” status. So the average American is actually impoverished and is lucky to get 40,000 yearly income. You see,over the years, Home prices increased much more than hourly wages and homes are probably overpriced by about 200 to 400 percent. The housing bubble needs to run it’s course and consequently that should reduce home prices to a more affordable level. Now all this will play out positively only if inflation is brought under control and actually reversed. Unless wages & income suddenly take a huge positive turn, we middle class americans will never afford to buy & keep a home.