Last Thursday, financial regulators said that they now fear that the banking industry turmoil will continue as financial institutions face the repercussions of an ocean of bad loans they made in the boom days of building new homes and condominiums. It's bad enough when homeowners default on their mortgages, but a bigger problem is unoccupied or unfinished homes which the bank can only unload at sacrificial prices. It looks like bank stocks won't recover anytime soon.
This is scary for U.S. stocks, since the health of the U.S. economy is heavily dependent on the willingness of banks and other financial institutions to lend to consumers and businesses. If they are short of funds, due to non-performing real estate loans, they can't make loans to other, more credit-worthy customers. According to a housing research firm, Zelman & Associates, U.S. banks could charge off between 10% and 25% of their residential construction and land assets in the next five years. That would amount to about $65 billion to $165 billion, or two to five times the inflation-adjusted $31.6 billion that was lost in the last housing downturn in the late 1980s and early 1990s. So far, through the first quarter of 2008, banks have officially written down just 0.7% of such assets, according to Zelman, so much bigger charge-offs are now pending, especially as market interest rates rise and the Fed may raise short-term rates later this year.
The prospect of a new wave of losses worries federal regulators, given the large proportion of bank loans that went to housing developers. The problems are worse at small banks that cannot easily absorb losses, especially at banks with big exposure in states hit hard by the housing crisis. For example, banks in Arizona have placed 36% of their loans in construction and development. The Zelman report said construction and development loans, as a percentage of total loans, are at their highest levels since at least 1975. As a result, it appears that a second wave of bank charge-offs is brewing, as foreclosures rise. According to the Mortgage Bankers Association (MBA), the number of new prime ARM foreclosures increased by 29,000 to 117,000 in the first quarter, while the number of new subprime ARM foreclosures increased by 20,000 to 195,000. This is the first time prime foreclosures have grown faster than subprime foreclosures according to the MBA.
According to the MBA, about 1.3 million homes were in foreclosure at the end of the first quarter. In that quarter, the foreclosure rate increased from 2.04% to 2.47% on a seasonally adjusted basis, while the number of loans that were at least 30 days past due climbed by 0.53% to a stunning 6.35%. If you are looking for some good news, 20 states actually experienced drops in the number of foreclosures last quarter, including Michigan, Ohio and Indiana. However, just four states (Arizona, California, Florida and Nevada) accounted for 89% of the increase in foreclosures. High property taxes, especially in California and Florida, compound the rising delinquency problem, as the housing crisis is now reaching out to more expensive neighborhoods.
