Community Banks Remain Under Stress

Editor's Note: This article was written by Richard Suttmeier, chief market strategist at ValuEngine.com, which is a fundamentally-based quant research firm in Princeton, New Jersey, that covers more than 5,000 stocks every day.


Since I've received several questions with regard to the status of community banks, today’s report is a summary of comments I've been making since April, 2006, when I first predicted a wave of bank failures as a result of overexposures (or heavy concentrations) to loans backed by construction and commercial real estate.

Here’s the background for regulatory guidelines that were established in December, 2006 and ignored ever since.
 

• Overexposure to construction and development loans: The first guideline states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loan concentrations above prudent risk levels, and should have heightened risk management practices.
  
  
• Overexposure to construction and development loans including loans secured by multifamily and commercial properties: If loans for construction, land development, and other land, and loans secured by multifamily and commercial property are 300% or more of total risk capital, the institution would also be considered to have CRE concentrations above prudent levels, and should employ heightened risk management practices.

The FDIC Lowers Its Estimate for 2010 Bank Failures

FDIC Chair Sheila Bair says that more than 140 banks will likely fail this year. While this would be more than in 2009, Bair says that the pace of failures is slowing. Bair implies that some of the banks on the FDIC list of problem banks have raised capital and have thus come off the list. The FDIC Chair says that failures will peak by the end of this year. Senator Dodd was also wrong when he said, "Community banks did not get us into this mess."

Here are the reasons I think the FDIC will be wrong: At the end of 2009 there were 380 publicly traded banks overexposed to C&D loans, and another 372 overexposed to CRE loans only. That’s 752 publicly traded banks that are candidates for the ValuEngine List of Problem Banks. Looking at all 8,012 FDIC-Insured Financial Institutions I find 1,514 overexposed to C&D loans, and another 1,312 overexposed to CRE loans only. That’s 2,896 banks or 36.1% of the 8,012 at risk of failure.

When I dissect loans versus loan commitments, which I call "pipeline," even more banks are feeling additional stress. A “normal” or “healthy” pipeline is when 60% of the C&D and CRE loans are outstanding versus a bank’s total commitment to these types of loans. Of the 8,012 FDIC-insured financial institutions, only 594 or just 7.4% have a pipeline between 55% and 65%. Most bank failures have a pipeline above 80%, which is a sign of collection problems: 4,172 banks or 52% have this stress characteristic. Of these, 1,406 have a pipeline that’s 100% funded, which is 17.5% of all banks.

The America’s Community Bank Index (ABAQ) had a “key reversal” on Monday. After setting a new 52-week high at $184.90 on Monday, the close was below Friday’s low of $182.57. The ABAQ is up 22.4% year-to-date and is up 70.3% since March 2009, but the index is 42.5% below its December 2006 high of $315.06. The chart shows that short term MOJO (12x3x3 daily slow stochastic) is extremely overbought with the 21-day simple moving average as support at $173.51. This week’s resistance is $186.21.



Commercial real estate loans expanded at a greater percent than GDP between the end of 2001 right through 2009. Nonfarm, nonresidential real estate loans are projected problems beginning this year. CRE loans are up 91.6% from 2001 through 2009, which is obvious continued stress for the banking system. Almost all bank failures have been FDIC-insured financial institutions overexposed the C&D and CRE lending. CRE loans are 91.6% since 2001 to $1.1 trillion.

Construction and development loans, a segment of CRE, rose at a dangerous pace right through 2007 and has declined in both 2008 and 2009. Between 2004 and 2006 this risky loan category grew at unsustainable annual rates of 23.7%, 33.2%, and 25.6%, as community and regional banks became overexposed to C&D and CRE loans. C&D lending was pure real estate speculation by community and regional banks, which occurred as the US Treasury, Federal Reserve, and the FDIC ignored their own regulatory guidelines. Our banking regulators are considering even tighter lending standards, which will choke job-creating projects developers and homebuilders want to begin today. This category is still up 95.0% since 2001 at $452 billion.