Of the nation’s 7,830 banks, 91% had assets under $100 million. Not surprisingly, small banks complain that bank examiners are overly conservative, especially in assessing their commercial real estate loans. Individually, they aren’t too big to fail, but collectively they are since smaller banks are the primary financiers of smaller businesses. Those businesses don’t have access to commercial paper and other credit market vehicles and must rely on their local banks for loans—or on the personal credit cards of their owners.
Ironically, in the go-go days, many of them were unwilling to virtually abandon their underwriting standards to compete with non-bank residential mortgage lenders. So they lent to the commercial real estate market instead, often residential construction-related firms.
As of last September 30, the FDIC had 860 banks on its “problem list” with an average of $440 million in assets, so more small bank failures lie ahead. Furthermore, many of the 600 banks that still have TARP money are small, weak institutions that have little access to alternative capital. And most of the 98 banks that got TARP money and are troubled are small ones with bad commercial real estate loans.
From June 2007 through 2008, banks with less than $10 billion in assets bought more than $4 billion in private-label mortgage bonds that are not issued or guaranteed by government agencies. Many of them were downgraded to junk status as homeowner defaults surged. Some of those banks believe the bonds will eventually pay off, but regulators forced them to reserve extra capital against likely losses.
The Achilles heel for medium and small banks is their troubled commercial real estate loans. Many more are likely to fail as those loans mature in the next several years.
Excerpts from the January 2011 edition of A. Gary Shilling’s INSIGHT newsletter