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Wednesday, July 2, 2008

Regional Banks: Dead Men Walking



(WSJ) Small Banks ‘Reckoning Day’ Is Coming: “Wall Street is bracing for regional and small banks to fess up to large losses from their mounting volume of soured construction loans made primarily to home builders.

According to the Federal Deposit Insurance Corp., $45.4 billion of the $631.8 billion in construction loans outstanding at the end of the first quarter were delinquent. When banks announce second-quarter results in coming weeks, they are expected to report sharp increases in loans that builders can't repay. Banks are also facing intensifying pressure from federal and state regulators to deal with the problem loans on their books.”

Put another way, 7.18% of all construction loans are CURRENTLY delinquent. These delinquency rates have nowhere to go but up as the economy slides into a recession. With residential and commercial real estate inventories to sales ratios climbing, new construction can’t compete with existing.

“That will put additional pressure on an already stressed financial system. Banks have begun to dump bad construction and land loans at discounts, curtail new lending and halt construction projects that are under way to preserve capital. Some analysts even see a wave of bank failures as a possibility.”

Bank failures a POSSIBILITY? Try a CERTAINTY.

“Nearly one in three of the banks analyzed -- or 2,182 -- had construction-loan portfolios that exceeded 100% of their total risk-based capital, a red flag to regulators, although it doesn't mean the bank is in danger of failing. Risk-based capital is a cushion that banks can dig into to cover losses.

Even more alarming, 73 of those banks had construction-loan delinquency rates of more than 25%. Executives at all of the banks that responded to questions acknowledged the problems but expressed confidence they had the capital to weather the storm.”

The weakest will fail quickly. Everybody else will languish for years. Zombification of the banking system will be the order of the day.

“Over the next few quarters, banks are expected to begin recording much larger losses. In 2007 and the first quarter of this year, U.S. banks wrote down just 0.7% of their residential construction and land assets as bad debt, according to Zelman & Associates, a research firm. Over the next five years that figure could rise to 10% and 26%, which would amount to about $65 billion to $165 billion, Zelman projects.”

The KBW Regional Banking Index (KRX) is a great way to play this out on the short side. Patience. Wait for those outsized Bear Market short covering rallies that always go further than you think possible.

Bounces just beyond the declining 50 day EMA (red line) have presented excellent short opportunities. Currently the decline is a little stretched, with prices having fallen so far and so quickly as to leave the declining 200 day EMA in the dust.

More on the KRX ETF here.

9 comments:

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Jenn in CA said...

very informative. I am going to be selling a 40 acre parcel of land with an owner carry and have been trying to figure out what a fair interest rate should be. I wanted 6.5% on a 30 year but my potential buyer wants 5%. Hmmm... you are making me think!

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