Financial Woes Spread to Smaller Banks

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Carlos Barria / Reuters

A pedestrian walks in front of a BankUnited branch in downtown Miami on May 22, 2009

If you want to know whether the banking crisis is in the third inning or the ninth, consider Corus Bankshares. The Chicago regional bank has made just over $4 billion in commercial real estate loans. The recently completed government bank stress tests assumed that as many as 12% of all such loans could go bad in the next two years. So Corus is looking at a potential loss of $480 million. How much capital does Corus have to absorb those losses? Nothing. Nada. In fact, Corus is already is the hole for $9 million. Call the failure hotline; we've got a live one, just barely.

Bank analysts and industry watchers say the financial crisis, which has so far been mostly focused on the nation's largest banks, is entering a new phase. Around the country, dozens of banks are nearing insolvency or soon will be. On May 21, BankUnited, based in Coral Gables, Fla., became the 34th bank to fail this year. It is the largest bank bust in 2009. BankUnited had 85 branches and $8.6 billion in deposits. (See pictures of the dangers of printing money.)

In a deal brokered by the Federal Deposit Insurance Corp., which closes banks that are insolvent or nearly so, BankUnited is being taking over by a group of private-equity investors, including famed vulture investor Wilbur Ross. The group isn't paying much for the bank — because BankUnited isn't worth much. The FDIC figures cleaning up the mess at BankUnited will cost its insurance fund nearly $5 billion, which makes this the most expensive bank failure this year.

"Up until a few months ago, I thought we were going to pull through this O.K.," says analyst James Abbott, who follows regional banks for FBR Capital Markets. "But now I am scared. For a lot of banks, this downturn does not look survivable."

As the larger banks did, regional banks made hundreds of billions of dollars in real estate loans. The smaller banks, though, lent mostly to commercial developers and home builders who, as business owners, have been able to hang on longer than the typical strapped consumer. But now that the recession is 16 months and counting, developers are facing the same problems that individual homeowners began facing two years ago. With vacancies in malls and office buildings around the country on the rise, more and more developers will be unable to pay their mortgages. And as those loans go bust, so too will more and more of our nation's smaller banks.

RBC Capital Markets analyst Gerard Cassidy says the U.S. banking system at the end of 2006 was more exposed to commercial real estate than at any other time that regulators have measured. That exposure, Cassidy believes, could result in as many as 1,000 bank failures by the end of 2012. "All the indicators on commercial real estate that we have seen suggest that there are real problems ahead for regional banks," says Cassidy. "It is just going to take a little while to get there."

The dark cloud over regional banks is bad news for the FDIC, which provides deposit insurance, now to the level of $250,000 per account, at banks across the nation. At the end of last year, the FDIC had only $19 billion left to cover future failures. That's the lowest the FDIC's insurance fund has been in more than 15 years. As a result, on Friday the FDIC decided to raise the fee it charges large banks for deposit insurance. Also, President Obama recently agreed to allow the FDIC to borrow as much as $100 billion, up from $30 billion, from the Treasury if its recovery fund needs it.

Some analysts believe that with the economy turning, commercial real estate loan losses will not be nearly as bad as Cassidy expects. But even under the government's baseline scenario for the banking industry, which was released as part of the stress test, U.S. banks could have as much as $84 billion in losses from commercial real estate. The government's adverse-case scenario suggests losses could reach as high as $200 billion.

"There are a large number of community banks that were very active in commercial real estate lending," says Robert Hartheimer, a Washington-based banking-industry consultant. "To the extent that the economy does not recover for a while, these types of loans are going to put a lot of stress on our nation's smaller banks."

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