Copyright 2010 Gannett Company, Inc.All Rights Reserved USA TODAY
January 21, 2010 Thursday CHASE EDITION
SECTION: MONEY; Pg. 1B
LENGTH: 1633 words
HEADLINE: Banks far from safe harbor; Critics fear big institutions still make risky moves; meanwhile, smaller ones deal with collateral damage
BYLINE: Paul Wiseman
Cattaraugus County Bank doesn’t exactly cruise in the fast lane of global finance. Two of its branches have hitching posts where Amish customers can tie up horse-drawn buggies.
“I don’t like picking up the paper and reading about fat cat bankers,” says bank President Salvatore Marranca. “I am not one of those.”
Marranca never dabbled in derivatives, never made speculative loans on strip malls and condo developments, never steered starry-eyed home buyers into McMansions they couldn’t afford, never cashed a multimillion-dollar bonus check. Yet, there he was, a couple of weeks ago, wiring $771,000 — more than the bank’s after-tax earnings last year — to Washington, D.C., to help patch up the leaky federal fund that protects depositors when bad banks fail.
“We’re paying for the sins of others,” Marranca says. Like other banks across the country, Cattaraugus County Bank had to pay the next three years’ worth of premiums in advance to keep the deposit insurance fund afloat after 140 banks failed in 2009.
The financial system has begun to recover from the worst crisis since the 1930s. But the scars still run deep. And the collateral damage has reached hamlets such as Little Valley in the hills of southwestern New York, where Cattaraugus County Bank has been making mortgages and writing loans to Main Street businesses for 108 years.
Even as banks report improved financial results for the fourth quarter of 2009, they continue to struggle to rid themselves of bad old loans and to make good new ones.
Critics worry that big banks are bigger and potentially more destabilizing than ever and are using their access to low-cost capital to make risky trading bets on currencies, commodities, stocks and bonds instead of making traditional loans.
“This is not a healthy combination,” says former Goldman Sachs executive Nomi Prins. “They’re making money from risky trades and losing money in their core lending business.” Prins is co-author of a report out this week from the Demos think tank, showing that through the third quarter of last year, big banks are increasingly reliant on trading revenue and are taking on more risk in their investment portfolios.
Signs of strength
By many measures, the financial system is looking stronger. Earnings are recovering. JPMorgan Chase, for instance, last week reported that fourth-quarter earnings rose nearly fivefold, to $3.3 billion.
Banks’ defenses against bad debts — capital and loan-loss reserves — are stronger. Citigroup this week said that it had stockpiled $104.6 billion in so-called Tier One Common capital — the first bulwark against loan losses — at the end of 2009, up from $22.9 billion a year earlier. Since early last year, bank shares have enjoyed a breathtaking rally in the stock market. And banks have repaid most of the money taxpayers gave them under the $700 billion Troubled Assets Relief Program (TARP) to restore calm to financial markets frozen in fear.
“There’s no doubt that the banking system is healthier than it was a year ago,” Herbert Allison Jr., assistant Treasury secretary for financial stability, says in an interview. “They’re in a much stronger position than they were when the crisis was unfolding.”
Banks earned back investor confidence after passing the Treasury Department’s “stress test” financial checkups last spring. That allowed them to go into the marketplace and raise $89.5 billion in common equity last year, up from $55.5 billion in 2008 and $8.3 billion in 2007, according to SNL Financial. The restoration of calm is reflected in the gyrations of the “TED spread” which measures the gap between the interest rates on interbank loans and rates on super-safe Treasury bills. At the height of the panic in October 2008, the TED spread widened to 4.65 percentage points, nearly 12 times larger than in ordinary times. These days, the spread is running around a quarter of a percentage point — a sign of renewed confidence in banks and in the government’s resolve to keep the financial system from going under.
Even so, the banking comeback has been mostly tepid so far. “We’re in a recovery,” says William Isaac, chairman of the consulting firm LECG Global Financial Services and former head of the Federal Deposit Insurance Corp. “It’s just not a very strong recovery yet.”
There are plenty of signs that things are not back to normal:
*Banks are still heavily dependent on government largesse. Christopher Whalen, managing director of the research firm Institutional Risk Analytics, says big bank profits “are almost entirely due to government subsidies.”
True, banks have paid back most of their share of TARP money. But they continue to hold $313 billion in low-interest loans made possible because the government guaranteed their debt under the Temporary Liquidity Guarantee Program. Through Dec. 31, the government had committed to pay loan servicers, including subsidiaries of Citigroup, JPMorgan Chase and Bank of America, more than $35.5 billion under the Home Affordable Modification Program, or HAMP, to share the cost of helping struggling homeowners keep their houses.
And the Federal Reserve last year announced a program to buy $1.25 trillion in mortgage-backed securities, supporting the weak housing market and propping up the value of banks’ mortgage-related assets. The purchases are supposed to wind down by March 31.
*Bad loans still menace bank balance sheets. Citigroup this week said it set aside $8.2 billion last quarter to cover loan losses. During the third quarter of last year, non-current loans rose across the industry to the highest level on record, according to the Federal Deposit Insurance Corp.; fourth-quarter numbers aren’t yet available for the entire banking system.
As banks continue to clean up bad loans from the residential real estate collapse, they face a new threat from a crumbling commercial real estate market. Office buildings are going empty, and retailers are struggling to pay rents in the worst economy in decades.
In a speech Wednesday, Sheila Bair, chairman of the FDIC, said commercial real estate prices have fallen 40% since autumn 2007, even more than housing prices. Non-current commercial real estate loans have climbed 250% in the past year to $44.8 billion, she said, and are likely to go higher.
The research firm Real Estate Econometrics expects defaults on commercial mortgages to rise from 4% last year to 5.2% in 2010 and 5.3% in 2011. And toxic commercial mortgages can be lethal to banks: Real Estate Econometrics studied 33 of last year’s bank failures and concluded that bad commercial real estate or construction loans were “a significant factor in each case,” says Sam Chandan, president of Real Estate Econometrics. Treasury’s Allison is confident, however, that most banks have raised enough capital to absorb a blow in commercial real estate.
Banks that were already seen as too big to fail are even bigger in the wake of crisis, swollen after consuming smaller competitors weakened by the housing collapse. Their size and complexity raise the risk of future bailouts and make it tougher for smaller banks to compete.
The five biggest banks have doubled their share of nationwide deposits to 40% since 1998 and have increased their share of nationwide banking assets to 48% from 26% a decade ago, according to the Demos report. Bair has said that the 2008 bank bailout and other government actions have signaled an explicit guarantee to prevent the very biggest financial institutions from failing.
“It puts us at a disadvantage,” says Mike Menzies, president of tiny Easton Bank and Trust on Maryland’s Eastern Shore. “Investors know a megabank can’t fail.” So big banks pay less to borrow or to raise capital than smaller banks do. The Center for Economic and Policy Research last year estimated that the lower funding costs provide the 18 biggest banks a subsidy worth up to $34.1 billion a year.
*Banks aren’t making new loans. Banks’ overall loans fell 7% in December from a year earlier, and their business loans dropped almost 17%, according to the Federal Reserve. Walter Todd, co-chief investment officers at Greenwood Capital Associates, says banks are missing an opportunity to take advantage of the wide gap — the yield curve — between the low short-term rates they pay for deposits and other funding and the higher rates they charge on longer-term loans, mortgages and credit cards.
“If you look at the yield curve environment, this should be a very lucrative period for banks,” he says.
Depending on customers
Bankers say they’d make good loans if they could. But borrowers these days are more interested in slashing debts and tightening their budgets.
“A bank is only as good as its customers,” says Dick Evans, CEO of Cullen/Frost Bankers in Texas. “Our customers don’t want to borrow money because there’s so much uncertainty about the economy.”
Bankers also say they’re getting mixed messages from government regulators. They’re being told to make loans to help the economy — and being ordered to stockpile more money as capital. “The government is speaking out of both sides of their mouth,” says Greenwood Capital’s Todd.
Evans also says bankers are worried about regulatory reform legislation pending in Congress that potentially would crack down on derivatives trading, establish an orderly process to shut down big troubled financial institutions, and create an agency to protect consumers from predatory lending and other financial abuses.
“I would drop it,” Evans says. “It’s not going to accomplish anything. There are plenty of good laws on the books. Let’s enforce the laws that we have.”
At Treasury, Allison is frustrated that bankers oppose reform legislation designed to prevent a repeat of the financial meltdown. “There’s a tendency to forget what’s just happened,” he says. “It’s troubling.”
LOAD-DATE: January 21, 2010