Summary
The housing bust has already made headlines from the subprime fallout, claiming dozens of mortgage banks, producing asset write offs approaching $300 billion on a global basis, and forcing many of the largest financial institutions to raise billions in new capital. Now smaller banks are going over the cliff at the expense of its shareholders and the FDIC. How many other banks are destined to fail? What are the drivers that will determine bank failures?
Analysis
ANB Bancshares was an aggressive $2 billion bank that bet its house on construction lending financed primarily by broker deposits. In 14 short years, this bank expanded to $1.3 billion by raising big chunks of insured deposits from brokers and concentrated 75% of its loan book in construction loans. When the housing boom turned to bust in 2006, many of its builders began to file for bankruptcy. ANB was not addressing the subprime market, yet it failed. Some basic banking principles were ignored, once again proving that there is too much of a "good thing." In some ways, this bank's failure is reminiscent of many bank failures of 1980s and early 1990s.
1. Other banks are destined to fail, the only unanswered question is how many. As of 12/31/2007, there were 76 FDIC-insured commercial banks and savings institutions on the “Problem List,” with combined assets of $22.2 billion. As of 12/31/2006, the list had 50 institutions with combined assets of $8.3 billion. The last recession (2002) yielded a peak of 136 problem institutions with combined assets of $39 billion. The number of failed institutions also peaked in 2002 at 11.
2. A key indicator of difficulty, and ultimately failure, is the “coverage ratio” of reserves to noncurrent loans fell to 93 cents at the end of 2007. This is the first time since 1993 that the industry’s noncurrent loans have exceeded its reserves. At year end, 33% of institutions had noncurrent loans that exceeded reserves up from less than 25% at 12/31/2006.
3. Some of the drivers that will determine bank failures in this cycle are high concentrations of construction lending, especially at institutions that have relied on broker deposits to finance these loans. While construction loans have attractive fee income and higher yields, the ultimate repayment of these loans is tied to the cyclical housing market. Current demand for new houses continues to fall in just about every market. Further, jumbo and broker CDs command a market rate and are not "core" deposits, so there is no franchise value associated with these deposits. ANB Financial concentrated 75% of its loan portfolio in construction lending and about 80% of its deposit base was Jumbo and broker CDs at 12/31/2006. This bank was just waiting to blow up.
4. How many more institutions will fail. Expect the total for 2008 + 2009 to exceed the totals from 2000 - 2003 (25). There are 141 institutions with construction loan portfolio concentrations exceeding 50% as of 12/31/2007. Thirteen of these institutions exceed $1 billion in assets.
