While the nation’s largest banks have been bolstered by federal bailout funds and equity-raising efforts, many smaller banks are still struggling with balance sheets tainted by bad commercial real estate loans.
When the FDIC seized Corus Bank earlier this month, the number of total bank failures reached 92 for the year—and two more have failed since. Corus, which was first incorporated in 1958 as River Forest Bancorp, was one of the largest of those failures, with $7 billion in assets and $7 billion in deposits.
But smaller, younger banks are going belly-up at an alarming rate. The FDIC recently noted that “de novo” banks, those opened in the last seven years, make up a disproportionate amount of recent bank failures. In all, 21 percent of bank failures since the beginning in 2008 were de novo banks—but from 2000 to 2007, those banks represented only about 10 percent of all failures.
So in late August, the FDIC issued new rules for young banks, subjecting them to higher capital requirements, and more frequent exams for their first seven years in operation, up from three years previously.
“The number of small banks exploded all throughout the country, and in any recession there’s going to be a flurry of these types of institutions that go bankrupt,” says Dan Fasulo, managing director of New York-based research firm Real Capital Analytics. “A lot of times, it comes down to a regional or community bank that made a series of major bets that went wrong.”
While TARP funds helped to bolster many of the nation’s largest banks, the Obama administration is now setting its sights on smaller institutions. The administration is reportedly developing an initiative to dole out TARP funds to community banks to help stave off further bank failures.
“The regulators were partially culpable for looking the other way as far as banks bulking up on real estate,” says Charles Krawitz, a senior loan sales asset manager at Cincinnati-based Fifth Third Bank. “But the government is trying to keep alive as many lenders as possible, so there’s a willingness to work with them to gradually unwind their commercial real estate holdings and not force them into liquidation mode.”
Small banks, by definition, aren’t as diversified as larger banks and are therefore at greater risk than their larger brethren. “Many of the community banks played in a lot of land and construction loans, and they’re not cash flowing,” says Chris Wolfe, a managing director at New York-based Fitch Ratings.
Fitch Ratings recently began surveying the nation’s community banks to provide data regarding the level of potential commercial real estate distress. One question the ratings agency hopes to answer is whether there are more troubled loans in community bank portfolios than there are bad CMBS loans in existence.
The troubles facing CMBS loans has long loomed over the commercial real estate industry, as defaults in that space continue to soar. But the problems at the small bank level haven’t made quite as many headlines. “There were more trophy properties financed through the CMBS industry, so those struggles were more visible," Wolfe says. “Whereas ‘First Bank of wherever’ may have had a construction portfolio blow up, but it doesn’t get as much attention, even though it’s meaningful.”
The problems in the CMBS world are also compounded by the fact that many CMBS loans were non-recourse, whereas the typical construction loan held on a bank’s balance sheet required recourse.
Still, lending conditions at community banks declined sharply in the second quarter, a trend that will likely continue throughout the first quarter of 2010, according to a recent survey of community banks conducted by Banc Investment Group (BIG). BIG produces a Commercial Real Estate (CRE) Index, a metric for measuring bank capacity for CRE loans. The latest results show that lending conditions at community banks have declined 28.7 percent since April 2007, with 11 percent of that decline happening in the second quarter of 2009 alone.
The FDIC said in late August that its watch list of troubled banks now numbers 416, up from 305 in March. In the second quarter, 111 lenders were added to the list, swelling the list to a 15-year high.
Those small banks that are able to weather the current storm will likely benefit from today’s consolidation. “There are thousands of small banks that have acted very responsibly, and many will come out of this in a much stronger position through less competition or being able to pick up their competitor’s assets on the cheap,” Fasulo says.