Toxic loans threaten 150 banks

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Since the beginning of 2009, 72 banks have failed; based on an analysis done by Bloomberg, 150 more are at risk. The culprit is all-too-familiar: according to the Bloomberg study, these endangered banks are in trouble because five percent or more of the loans they hold are nonperforming. That means the bank is no longer collecting interest on a loan or that the loan will not be paid in full. Yet, even with these statistics, many banks are resisting the FDIC Legacy Loan Program. Meanwhile, instead of trying to help banks in trouble, the FDIC is using the program to deal with the toxic assets of failed banks.

Based on Bloomberg's analysis, the 150 banks with nonperforming loans above five percent had combined assets of $193 billion, which is almost 15 times the size of the FDIC's deposit insurance fund at the end of the first quarter. The list of problem banks -- a confidential list developed by U.S. bank regulators -- had 305 members in the first quarter. Institutions on the problem list are not revealed for fear that doing so would cause a run on the bank and make the situation even worse.
Bloomberg did, however, name the three lenders with nonaccruing ratios of at least 6.5 percent that are still open: Chicago-based Corus Bankshares (CORS), Austin-based Guaranty Financial Group (GFG) and Colonial BancGroup (CSB) in Montgomery Alabama. In the past month, all three have said that they expect to be shut down.

Last week, the FDIC shut down three banks with nonaccruing ratios of 6.2 percent: The First State Bank of Sarasota (Florida), Community National Bank of Sarasota County (Florida), and Oregon's Community First Bank of Prineville.

This isn't to say that all nonaccruing asset-heavy banks are dead. The biggest institutions with nonpeforming assets of at least 5 percent include Wisconsin's Marshall & Ilsley (MI) and Georgia's Synovus Financial Corp. (SNV). Michigan's Flagstar Bancorp (FBC) is the largest bank in all 50 states that continues to operate with 10 percent nonperforming loans.

Last Friday's three bank closures were expected the cost the FDIC fund $185 million, which brings the total 2009 cost for failed banks to $16.58 billion. That compares to a total cost to the fund of $17.6 billion for all of 2008. Last year, the total number of bank failures was 25, so we're just a bit more than halfway through the year and already almost three times the number banks have failed. Interestingly, stress tests were only done on 19 of the largest banks.

This report gives credence to the Congressional Oversight Report issued earlier this week, which indicated that many banks are still at risk if their toxic assets are not taken off the books. Large commercial loans are the primary threat to smaller banks. As owners of shopping malls, hotels and offices default on loans more rapidly, the smaller banks that hold many of these loans will suffer. Experts think that the bottom for the commercial real estate market is still three years off. Meanwhile, delinquency rates on loans doubled in the past year to 7 percent. The Federal Reserve expects more companies to downsize and more retailers to close their doors, leaving office and retail space vacant.

The Congressional report said that small banks "will need to raise significantly more capital, as the estimated losses will outstrip the projected revenue and reserves [...] Failure to start the Legacy Loan Program raises concerns about Treasury's strategy.

About 2.6 percent of the $7.74 trillion in bank loans outstanding in the U.S. were nonaccruing, according to data from the FDIC. That's the highest rate in 17 years. The normal average for nonaccruing loans is 1.54 percent, and the last time that the rate approached this level was during the savings and loan crisis, when 3.27 percent of loans were nonaccruing.

Clearly, the FDIC needs to find a way to get the toxic loans off the books of small banks before they fall over the cliff and their nonperforming loans equal 5 percent or more of their holdings. Former regulators agree that's the tipping point that threatens a bank's survival. While many analysts wonder why they are waiting until banks fail, a better question might be why bank managers are waiting until the FDIC closes them, rather than volunteering to work with the Legacy Loan Program before it's too late.

Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies.
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