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Is Your Local Bank in TARP Trouble? |
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FORECASTS & TRENDS E-LETTER IN THIS ISSUE: 1. Small Banks in Trouble Due to TARP Money 2. See if Your Local Bank Took TARP Money 3. The Commercial Real Estate Bust Continues 4. Many Banks “Extend and Pretend” 5. The Economic Recovery Will Remain Weak Introduction You’ve probably read recently that most of the 17 largest banks that took Trouble Asset Relief Program (“TARP”) money have paid it back, with interest. They are no longer on the government dole. However, a new report from the Congressional Oversight Committee warns that over 600 smaller banks that took TARP money may not be able to pay it back. And the list is growing. Furthermore, the report warns that if these community banks can’t pay the government back, they will have to be merged with other larger banks or go out of business altogether. The report also acknowledges that these TARP loans, which smaller banks were encouraged to take, should never have been offered in the first place. Surprise, surprise. President Obama wants to create a $30 billion relief fund for these banks that are in trouble, but it seems to be going nowhere in Congress. Plus, some experts believe that $30 billion is not nearly enough to save the 641 smaller banks that may be in financial trouble primarily due to taking TARP money. Action to Take: If you deal with a local bank, you should inquire as to whether or not they took TARP money and if they have paid it back. Following that discussion, we take a fresh look at the current status of the US commercial real estate market. In short, the news is dreadful. The value of the collateral backing US commercial real estate loans has plunged from apprx. $6 trillion in 2007 to only $3-$3.5 trillion at the beginning of this year. The reason: commercial real estate values have collapsed. Making matters worse, the number of commercial real estate loans reaching maturity, and needing to be refinanced, will reach new highs over the next few years. Thousands of properties will almost certainly be foreclosed upon, thereby making matters even worse. This dilemma does not bode well for the economic recovery. Small Banks in Trouble Due to TARP Money Last Wednesday, the Congressional Oversight Panel released a troubling new report on the state of small banks that took TARP money during the financial crisis. You may recall that Congress created the Congressional Oversight Panel (“COP”) in late 2008 when it authorized the Treasury to create the $700 billion TARP to bail out struggling banks. The COP’s initial mission was to “review the current state of financial markets and the regulatory system.” It was given broad powers and authority to hold hearings, review official data, and write reports on actions taken by the Treasury and financial institutions and their effect on the economy. Basically the COP was Congress’ way to look over the shoulder of the Treasury. The COP’s latest 130-page report paints a grim picture for the over 600 small banks that took TARP money in late 2008 and 2009. Basically, many smaller banks that borrowed TARP money are having trouble paying it back. The report warns that these banks may become vulnerable to takeovers or being shut down as a result. According to the report, the Treasury lent over $25 billion of TARP money to 690 small banks – those with less than $100 billion in assets – aiming to stabilize them amid the financial crisis that struck in full force in late 2008. But many of the more than 600 smaller banks that got help “are now struggling to meet their obligation to taxpayers.” As you will recall, most of the TARP money went to the 17 largest banks with assets over $100 billion, and they have emerged from the crisis relatively well. The report notes, “Most of these large banks have already repaid taxpayers, and many are now reporting record profits.” Yet many smaller banks are now having difficulty raising the capital necessary for repayment of their bailout funds, and by 2013 they face the prospect of having to pay higher charges for the TARP money that they received. As with the largest banks, the smaller banks had to put up their own stock as collateral for the TARP loans, and according to the new COP report, those banks are required to pay the government a 5% annual dividend on their stock. In 2013, that dividend goes up to 9%, which will make it even harder for these banks to pay back the loans. The Congressional Oversight Panel’s chairwoman, Elizabeth Warren, said it was ironic that the government’s bailout program seemed to be offering its greatest benefit to big Wall Street banks when it was intended to stabilize the whole industry. She added, “TARP was not intended as a bailout for Wall Street, it was intended to provide benefit for the whole economy.” The COP report warned, “If they are unable to access new capital by the time the dividend rate increases [in 2013], more small banks may become trapped, with no way either to escape the CPP [TARP loans] or to pay their required dividends.” The report further warns that this dilemma might leave small banks vulnerable as takeover targets, or force them into receivership by the FDIC. The report goes on, “Consolidation or failure may be appropriate for some weak and poorly managed banks, but it would be unfortunate if well-run institutions were forced onto this path solely because of the CPP [TARP loans],” adding that the effect of the bailout on smaller banks may have been to weaken them. The report warned that “the number of small banks that were once deemed healthy but that cannot make their dividend payment and repay their TARP obligations may grow,” adding that the end effect will be to further restrict lending and dampen the economic recovery. The report states that one in seven small banks that took TARP money has already missed a dividend payment, and fewer than 10% of these 600+ banks have repaid taxpayers. Ms. Warren warned, “We are trying to wave a flag about a problem that’s already serious and is very likely to get worse,” particularly because many smaller banks have significant exposure to the commercial real estate market where borrowers are defaulting in growing numbers. I will have much more detail on the distressed situation in commercial real estate below. Ms. Warren admits that the TARP loans to smaller banks probably never should have been made in the first place. The Treasury Department says it was an issue of fairness. To extend TARP only to the large banks would have put them at an unfair advantage over smaller banks. It now looks like that decision to make TARP money available to smaller banks (made by Bush’s Treasury Secretary Hank Paulson) backfired. President Obama has been pushing for the creation of a special $30 billion fund to boost capital at small banks, but Ms. Warren doubts that this would be nearly enough relief to fix the problems with the dividend payments at smaller banks, much less the repayment of the TARP loans. The bottom line is that this Congressional Oversight Panel report is sending two major warnings: 1) that some, perhaps many, of the over 600 banks that took TARP money will not be able to pay it back; and 2) if they can’t pay it back, they won’t be bailed out again. The report warns that they will have to be merged with other banks, or go out of business. Action to Take: Check with your local bank to confirm that it is not one of the 690 that took TARP money. If it did, then you need more information on where they stand in terms of repayment. Finally, here are links to two websites that list the banks that took TARP bailout money; I cannot attest to their accuracy, but they seem to be legitimate: http://bailout.propublica.org/list/index http://money.cnn.com/news/specials/storysupplement/bankbailout/ The Commercial Real Estate Bust Continues As the Congressional Oversight Panel report emphasized, most smaller (and regional) banks have significant exposure to commercial real estate (“CRE”). And the situation in this key sector continues to worsen. Let’s put it in some perspective. At the height of the housing bubble in 2007, the value of the collateral underpinning total outstanding commercial real estate debt was estimated to be around $6 trillion. At the beginning of this year, it was estimated to have collapsed to $3-3.5 trillion. Yet the CRE market is still over four times the size of the entire credit card market. Making matters worse, commercial real estate transactions collapsed 90% from 2007 to the end of 2009 – from $522 billion in sales to only $52 billion as shown in the following chart.
It is obvious that commercial real estate values have plunged in many, if not most, areas around the country. A few areas of the country have been largely spared, but the chart below is a reflection of CRE values as a national average. As you can see, the plunge has been devastating, even though we don’t hear a lot about it in the mainstream media. But we will in the next few years as the loans have to be renewed!
It is an understatement to say that the CRE market is underwater! It is painfully clear from the chart above how big the CRE bubble was and how incredibly fast it imploded. As the chart illustrates, CRE market values soared for seven straight years. Then most of that value disappeared in roughly a year-and-a-half. The reasons why the commercial real estate market collapsed are in many ways similar to those that led to the housing meltdown. Prices had gone up so fast that the CRE market became a speculative boom. Lending became much too easy with relaxed credit qualification. In the past, CRE deals were scrutinized in advance for strong financial reports, and most projects began the loan process with sizable downpayments. Most projects were expected to generate cash flow almost immediately upon completion. But as the credit bubble grew, lending standards were relaxed significantly, projections were greatly overstated and, of course, then came the financial crisis and the recession. As noted earlier, the collateral behind outstanding debt in the CRE market is estimated to be around $3.5 trillion, second only to home mortgages which are estimated to be $4.5-$5 trillion in loans outstanding. Here again, this is a huge problem that we don’t hear much about – yet. The collapse in the CRE market, and its devastating effects on small and regional banks, is a big reason why the banks are not lending, and this is one of the primary reasons why the economic recovery is so tepid this year. As noted above, many of the banks that are struggling have significant exposure to commercial real estate loans that are now underwater, including many that took TARP money and now can’t pay it back. But the problem is not limited to those 641 small banks that took TARP money and have not paid it back. While their dilemma may be worse than small banks that did not take government bailout money, the collapse of the commercial real estate market is endemic to almost all small and regional banks. This suggests that lending among small and regional banks could be anemic for another several years, at least, as they work through the serious problems with CRE loans already on their books. By now, I’m sure you have come to realize that the $3.5 trillion in collateral backing outstanding commercial real estate debt is a serious problem. Unfortunately, we haven’t seen the worst of it yet, as the following chart illustrates.
As you can clearly see, the number of commercial real estate loans that are coming due is projected to rise each year from now until 2013 and will remain high until 2018 according to research by Foresight Analytics. CRE loans, unlike traditional home mortgages, are typically structured to roll over (refinance) every 5-7 years. In a normal economy with positive cash flows on most CRE properties, there is usually no problem in renewing these loans. But of course, we are not in a normal economy, and bank lending is down over 25% in the last couple of years. According to research by JP Morgan, the worst of the CRE loans were originated in 2006 and 2007, many of which were collateralized by properties that were overvalued and in many cases, highly leveraged as well. These ugly underwater loans will have to be refinanced over the next few years, which could result in more downward price pressure. When we combine this dilemma with the continued weakness in the housing market, you have a recipe for a continued slow economy, or maybe a double-dip recession, for the next couple of years or longer. At the very least, this explains why many small banks can’t repay their TARP loans and may well go out of business or be merged over the next few years. “Extend and Pretend” Some banks have a special technique for dealing with business borrowers who can’t repay loans coming due: Give them more time, hoping things improve and they can repay later. Banks call it a wise strategy. Skeptics call it “extend and pretend.” Banks are applying it, in particular, to commercial real-estate lending, where, during the boom, optimistic borrowers got in over their heads to the tune of tens of billions of dollars. But the practice is creating uncertainties about the health of both the commercial property market and many banks. The concern is that rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets.
The Economic Recovery Will Remain Weak I have maintained all year that the US economic recovery would be weaker than most forecasters suggested at the beginning of this year. I have also warned that a double-dip recession is not out of the question. Historically, deep recessions are followed by strong economic expansions, but not this time. The credit crisis of 2008-2009 was unprecedented, and bank lending remains in the tank – down over 25% (and this number is underestimated, in my opinion) – from pre-crisis levels. And the news continues to get even worse. The latest Congressional Oversight Committee report is chilling, both in terms of the 641small banks that haven’t been able to repay their TARP loans, and the warning that many of these banks will have to be taken over or go out of business altogether. Add to that the fact that most small and regional banks have significant exposure to commercial real estate that has plunged in value, and you have a recipe for a continued period of weak bank lending. Overall bank lending is not likely to rebound significantly anytime soon, and this suggests a continued weak economic recovery and high unemployment. ** Be sure to read the P.S. below my signature. Wishing I had better news,
Gary D. Halbert P.S. An Investment Event You Won’t Want to Miss! As my long-time readers know, my Investment Advisory firm often sponsors live seminars via the Internet, often called “webinars,” that feature a variety of money management styles. On August 5th, we’ll be offering the latest in our series of webinars featuring the Long/Short Government Bond Program managed by Hg Capital Advisors, Inc. Considering the current state of the bond market, I believe this is a webinar you won’t want to miss. With interest rates at or near historical lows, you may think that this would be an odd time to be featuring an investment strategy based on the 30-year Treasury bond. Conventional wisdom says that you should be moving out of bonds at this point in time, since interest rates are sure to start moving up at some point in the future. Even Bill Gross, manager of the world’s largest bond mutual fund, recently warned that US Treasury bonds have “seen their best days” and advised investors to head for the exits. Yet, despite Wall Street’s conventional wisdom, long-term government bonds were the single best performing asset class for the first half of 2010. While we fully expect Mr. Gross to be right in the long run, there are short-term opportunities that can be exploited IF you have an investment strategy nimble enough to capitalize on both up and down movements in long-term bond yields.
Of course, past performance can’t predict future results and the ability to trade both long and short, coupled with 1.2X leverage on the long side, means that the Hg bond strategy is generally suitable only for the aggressive portion of an overall portfolio. However, for suitable investors looking for a way to potentially capitalize on trends in long-term bond yields, Hg Capital’s Long/Short Government Bond Program may be just what you’re looking for. Our live webinar will feature Byron Haven and Ted Lundgren, two of Hg Capital’s principals and the developers of the bond strategy. You will be able to hear them describe their approach to the 30-year Treasury bond market and how they seek to capitalize on both rising and falling yields. You will also be able to ask them any questions you may have about their strategy and performance. Again, the Hg Capital Long/Short Government Bond webinar will be held on Thursday, August 5, 2010 at 1:00 PM Eastern (10:00 AM Pacific). Seating is limited so I encourage you to click on the following link to register for the upcoming webinar at your earliest convenience: https://www1.gotomeeting.com/register/460995961
SPECIAL ARTICLES:
Commercial Real Estate Crisis, Downward Spiral for Local Banks
To Fix Sour Property Deals, Lenders “Extend and Pretend” |
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About two-thirds of bank commercial real estate loans maturing between now and 2014 are underwater, meaning the property is worth less than the loan on it, according to Foresight Analytics data. US commercial real estate values remain 42% below their October 2007 peak and only slightly above the low they hit in October 2009, according to Moody’s Investors Service. In the 1Q, 9.1% of commercial property loans held by banks were delinquent, compared with 7% a year earlier and just 1.5% in the 1Q of 2007, according to Foresight.
