FDIC: Troubled Real Estate Loans Trigger Higher Provisions for Losses, Weaker Profits

Posted under Recession by Darren Hom

On May 29, the FDIC issued a press release indicating concern that more loan losses are accentuating the credit stress already felt in the market.

Restatements of fourth-quarter 2007 profits by a few institutions, primarily reflecting additional charges for goodwill impairment, reduced industry earnings for that quarter from the $5.8 billion previously reported to $646 million. That is the lowest quarterly net income for the industry since insured institutions posted an aggregate net loss in the fourth quarter of 1990….

Noncurrent loans are still rising sharply. Loans that were noncurrent (90 days or more past due or in nonaccrual status) increased by $26 billion (or 24 percent) to $136 billion during the first quarter. That followed a $27 billion increase in the fourth quarter of 2007. Almost 90 percent of the increase in noncurrent loans in the first quarter consisted of real estate loans, but noncurrent levels increased in all major loan categories. At the end of the first quarter, 1.7 percent of the industry’s loans and leases were noncurrent.

Earnings remain burdened by high provisions for loan losses. Rising levels of troubled loans, particularly in real estate portfolios, led many institutions to increase their provisions for loan losses in the quarter. Loss provisions totaled $37.1 billion, more than four times the $9.2 billion the industry set aside in the first quarter of 2007. Almost a quarter of the industry’s net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves.

The industry’s “coverage” ratio — its loss reserves as a percentage of nonperforming loans — continued to erode. Loan-loss reserves increased by $18.5 billion (18.1 percent), the largest quarterly increase in more than 20 years, but the larger increase in noncurrent loans meant that the coverage ratio fell from 93 cents in reserves for every $1.00 of noncurrent loans to 89 cents, the lowest level since 1993. “This is a worrisome trend,” Chairman Bair said. “It’s the kind of thing that gives regulators heartburn.”

The early 1990’s were an optimum time to buy loans and discounted real estate. That time will come again soon.

She added, “The banks and thrifts we’re keeping an eye on most are those with high levels of exposure to subprime and nontraditional mortgages, with concentrations of construction loans in overbuilt markets, and institutions that get a large share of their revenues from market-related activities, such as from securities trading.”

The FDIC’s Deposit Insurance Fund (DIF) reserve ratio fell. The DIF increased by $430 million (0.8 percent) during the first quarter, ending with a balance of $52.8 billion. The growth in the DIF, which was restrained by loss provisions of $525 million, did not keep pace with the quarter’s $140.5 billion (3.3 percent) increase in insured deposits. As a result, the fund’s reserve ratio declined from 1.22 percent to 1.19 percent during the quarter. Total deposits of FDIC-insured institutions increased by $150.4 billion (1.8 percent). Deposits in domestic offices rose by $156.2 billion (2.3 percent), while deposits in foreign offices declined by $5.8 billion (0.4 percent).

In particular:

The FDIC cited higher provisions for loan losses as the primary reason for the drop in industry profits….

Almost a quarter of the industry’s net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves.

With banks’ money tied up in this way, the money to refinance poorly performing loans is becoming even less available.

It will be time to buy when there is blood in the streets. The wounds are getting harder and harder to bind.