Capital Markets

Fed Official: More Bank Losses, Writedowns Loom

Companies trying to obtain credit may soon find an even more unfriendly environment.

A Federal Reserve official painted a bleak picture of the outlook for U.S. banks on Wednesday, saying he expects more losses and writedowns from financial institutions for coming quarters. That, combined with recent benchmarking data on middle-market loan portfolios, suggests the lending environment could get even more unfriendly for companies trying to obtain credit.

In testimony before the Senate committee on Banking, Housing, and Urban affairs, Fed Vice Chairman Donald Kohn predicted bank holding companies would continue “to report weakening earnings and further asset valuation writedowns and/or significant credit costs in coming quarters.”

The deteriorating quality of loans in banks’ portfolios will not abate, Kohn said, because of sharply declining house prices, which spark losses in lending tied to residential real estate, and overall “weak economic conditions.” The problems could extend to other segments of lending, he said, including corporate loan portfolios.

For the 50 largest bank holding companies, nonperforming assets have more than doubled over the past year, to $81 billion at the end of the first quarter, according to Kohn. As a share of total assets, they have reached their highest level since 2002.

Other statistics detail the pervasiveness of the decline in credit quality. Analyzing first-quarter middle-market portfolio data from 17 top-tier banks, The Risk Management Association recently reported that middle-market loans on “nonaccrual”—that is, contractually past due 90 days or more—represented 0.83 percent of total outstanding balances, a 26 percent increase over the prior quarter. Loans tied to the construction sector lead the deterioration, with 2.55 percent of them being reported as nonaccruing. Loans in arts, entertainment, and recreation (1.99 percent); retail trade (1.10 percent); and manufacturing (1.02 percent) are also performing poorly.

Middle-market nonacrrual and delinquent loans—those 30 days to 89 days past due—are now at their highest level since March 2004, the RMA said.

As of now, despite higher provisioning for loan losses in recent quarters, banks’ reserves have not kept pace with the growth in problem assets, Kohn said. To bolster loan loss reserves, banks will need further capital injections and need to consider dividend cuts, he said, to maintain “sizable and more reliable” liquidity and capital cushions. “We have strongly encouraged supervised bank holding companies to enhance their capital positions,” Kohn said.

Supplying evidence of banks’ thirst for capital, the Fed’s latest term-loan auction, designed to boost banks’ liquidity, recorded a big jump in bids. The regulator received 73 bids requesting a total of $95.9 billion, up from $84.4 billion in its previous auction in May.

“The world of financial services companies is breaking into the ‘haves’ and ‘have-nots’,” Mark Sunshine, president of lender First Capital told “While the have’s earnings may not be robust, they’re out there and looking to grow assets; but for the have-nots who drank the Kool Aid of high leverage and fast money, it is really tough.” Sunshine’s advice to borrowers: don’t wait for a company loan to come up for refinancing. Instead, seek out capital from other providers.

Kohn did not outline any new steps the Fed would take to stem the hemorrhaging at banks. But he did say that examiners are “reviewing due diligence around commercial real estate valuations and ensuring that bankers make appropriate adjustments based on market conditions.”

The Fed official’s remarks come on the heels of a downgrade of Morgan Stanley, Merrill Lynch, and Lehman Brothers Holdings by Standard & Poor’s on Tuesday.

Stated S&P credit analyst Scott Sprinzen: “The downgrade primarily reflects our concern that the pace and extent of earnings improvement [at the three banks] could be considerably more muted than we previously anticipated.”