Big loan losses could hit $53 billion

Banks, hedge funds, insurance companies and pension funds could face an additional $53 billion in large loan losses according to the annual Shared National Credit Review released Thursday. The examiners considered loans of at least $20 million and underwritten by three or more banks to finance commercial real-estate projects, corporate buyouts and other big ticket items.

This Shared National Credit exam is conducted yearly by four federal bank regulatory agencies. The number of loans tagged as "substandard," "doubtful" or "loss" nearly tripled to $447 billion, or 15.5 percent of the total loans reviewed. That's up from 5.8 percent last year.Nonbanks held 47 percent of the troubled loans even though they own just 21 percent of the total $2.9 trillion big ticket loans on the market. In other words, banks sold off more of the most speculative loans to hedge funds, insurance companies and pension funds. Before the bubble burst in 2007, these large, speculative loans were easier to get and underwriting was "structurally weak."

Foreign banks could also be hard hit by this report. They hold about 38 percent of the $2.9 trillion in loans. Some U.S. banks have already warned that because of this federal exam, third quarter results will show a loss. For example, Fifth Third Bancorp of Cincinnati (FITB) expects to report a $110 million loan loss in the third quarter because of the exam results, which Chief Executive Kevin Kabat said was higher than expected.

Regulators started to inform the nation's top few banks about the exam findings in the second quarter, but most banks were not informed until the third quarter. Federal regulators started to disclose their findings to small banks last month. As the news leaked out on Thursday, bank stocks dropped 2 percent on the KBW index.

The sharpest pain is expected to be felt the by the large regional banks, which helped to underwrite huge loans with lax terms until mid-2007, when the credit crisis started to unfold and the housing markets collapsed.

The news does not come as a complete surprise. The writing has been on the wall for awhile. Last May, I wrote about how smaller banks likely would face trouble because of their commercial lending. At that time, I wrote that U.S. small banks and thrifts, which hold $1.8 trillion of commercial real estate on their books, could incur $216 billion in losses by the end of 2010. With the new information released in the Shared National Credit review, these loses could go even higher.

Nearly 3,000 banks and thrifts are estimated to have commercial real estate loan portfolios that exceed 300 percent of their total risk-based capital, according to Foresight Analytics. Regulators consider 300 percent a red flag, but it doesn't mean all the banks above that threshold will fail.

While the failure of small banks is unlikely to cause systemic damage, it could still have a big impact just as the government appears to be having some success pulling us out of this crisis. To give you an idea of the scope of the problem, the banks with commercial real estate loan portfolios exceeding 300 percent of their total risk-based capital have total assets of about $2 trillion, compared with $2.3 trillion in assets at Bank of America (BOA).

So far, banks have been reluctant to sell their troubled commercial property loans because they would be insolvent if they sold those assets at their current bargain-basement prices. Regulators could put pressure on these banks to clean up their books. The ones in the worst shape could be seized by regulators and put under conservatorship or receivership.

Lita Epstein has written more than 25 books, including The Complete Idiot's Guide to the Federal Reserve and Reading Financial Reports for Dummies.
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