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• MAY 19, 2009

Local Banks Face Big Losses

Journal Study of 940 Lenders Shows Potential for Deep Hit on Commercial Property

By MAURICE TAMMAN and DAVID ENRICH

Commercial real-estate loans could generate losses of $100 billion by the end of next year at more than 900 small and midsize U.S. banks if the economy's woes deepen, according to an analysis by The Wall Street Journal.

Such loans, which fund the construction of shopping malls, office buildings, apartment complexes and hotels, could account for nearly half the losses at the banks analyzed by the Journal, consuming capital that is an essential cushion against bad loans.

Under Stress: Testing the Rest

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Total losses at those banks could surpass $200 billion over that period, according to the Journal's analysis, which utilized the same worst-case scenario the federal government used in its recent stress tests of 19 large banks. Under that scenario, more than 600 small and midsize banks could see their capital shrink to levels that usually are considered worrisome by federal regulators. The potential losses could exceed revenue over that period at nearly all the banks analyzed by the Journal.

The potential losses on commercial real estate are by far the largest problem facing the midsize and small banks, easily exceeding losses on home loans, which could total about $49 billion, according to the Journal's analysis. Nearly one-third of the banks could see their capital slip to risky levels because of commercial real-estate losses, the Journal found.

The Journal, using data contained in banks' filings with the Federal Reserve, examined the financial health of 940 small and midsize banks. It applied the loan-loss criteria that the Fed used in its stress tests of the largest banks.

The findings are a stark reminder that the U.S. banking industry's problems stretch far beyond the 19 giants scrutinized in the government stress tests. Regulators and investors have focused on too-big-to-fail banks such as Bank of America Corp. and Citigroup Inc. But more than 8,000 other lenders throughout the country are being squeezed by the recession and real-estate crash.

"They are in just much worse shape" than the big banks, says Terry McEvoy, an Oppenheimer & Co. analyst who reviewed the Journal's analysis. "There is a lot less earnings power at these banks."

The Fed this month estimated that the 19 stress-tested banks could face losses of $599 billion if the agency's gloomiest economic scenario comes true. For the 10 large companies found to need additional capital, most of the shortfalls are manageable.

Few smaller banks are likely to attract the bargain-hunting investors now expressing interest in recapitalizing the industry's giants. Many smaller banks are trying to bolster their capital by selling assets and making fewer loans.

A further drop in lending threatens to prolong the recession. "It's certainly a challenge for the economy," says Allen Tischler, a senior credit officer at Moody's Investors Service.

Banks unable to replenish capital could face a tightening regulatory vise. Some of the weakest institutions are likely to fail, although few analysts predict anything close to the 1,256 closings between 1985 and 1992. Regulators have seized 58 banks since the start of 2008, including 33 so far this year.

In the government's stress tests, the Fed measured how much capital banks might need to raise to achieve a so-called Tier 1 common capital ratio, or capital buffer, equal to 4% of assets.

The Journal's stress-test analysis includes 940 bank-holding companies that filed financial reports with the Fed for the year ended Dec. 31. The companies range from large regional banks to mom-and-pop banks in rural towns. The financial reports also include U.S.-based subsidiaries of foreign banks.

The banks examined by the Journal had total assets of $2.8 trillion at year end. That is less than the combined assets of Bank of America and Wells Fargo & Co., two of the nation's largest banks. The 19 big banks that underwent a Fed stress test weren't included in the Journal's calculations.

The Journal projected potential losses by using the "more adverse" scenario in the government's stress test -- the scenario the Fed used to calculate how much capital the big banks should raise. That worst-case hypothetical situation includes a 2010 unemployment rate of 10.3%, compared with 8.9% in April, and a two-year cumulative loss rate of as much as 12% on commercial real-estate loans and as much as 20% on credit cards. [more]