Real Estate Lender Implosion

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Fed's Kohn says banks face 'challenges,' but does not predict failures UPDATE

03.04.08, 10:45 AM ET


(updates with Fed actions)

WASHINGTON (Thomson Financial) - Federal Reserve Board Vice Chairman Donald Kohn today acknowledged that banks are likely to face more loan delinquencies and asset write-downs in the coming months, but indicated banks will be able to weather this storm, and did not predict a wave of new bank failures, something Fed Chairman Ben Bernanke predicted last week.

At a Senate Banking Committee hearing today, Kohn said the collapse of the mortgage market and asset-backed securities, and the credit tightening that followed, led to losses at many banks. He predicted more asset write-downs at large bank holding companies, but did not make a specific prediction.

Kohn also said there was a 'moderate overall decline in liquid assets' as a portion of total assets at bank holding companies, which together hold more than 14 trln usd in assets, and said 'strains have emerged in term interbank funding markets.'

'But in general these losses should not threaten their viability,' he told the committee.

Kohn noted that bank holding companies still reported net income of 90 bln usd in 2007, despite losses of more than 8 bln usd in the last quarter of the year. He added that while the non-performing asset ratio of these holding companies increased, the ratio was still lower than levels it reached earlier in the decade.

Kohn also pointed out that these holding companies have still maintained their required capital ratios, and said the largest companies are still managing to raise capital.

Kohn said state-member banks, which are regulated by both the Fed and state authorities, saw non-performing assets rise 'sharply' in the past year, and said the percentage of these banks with less-than-satisfactory supervisory ratings rose from 4.5 pct in 2006 to 6.3 pct in 2007.

'Like bank holding companies, these banks face deteriorating credit conditions in 2008 and we anticipate further increases in their loan delinquencies and charge-offs,' he said. 'We also foresee more difficult liquidity conditions for some of these banks,' and more banks with less-than-satisfactory ratings.

One trouble spot for smaller banks could be their exposure to commercial real estate loans, for which delinquencies doubled in 2007 to a rate of more than 2 pct. Kohn said small and medium-sized banks have 'sizable exposure' to commercial real estate loans, and said some banks were not effective in managing their exposure to this sector of the market.

Kohn said the Fed is planning a review on this issue to identify banks more at risk in this area.

Kohn outlined a range of activities that the Fed is undertaking to ensure banks can improve their risk management practices, but said the Fed itself must improve the way it oversees large bank holding companies and member-state banks.

'As supervisors, we must redouble our efforts to ensure risk management practices and controls keep pace with changes in financial markets and business models, providing both positive incentives and clear consequences,' Kohn said.

He said many banks were not aware of the risks of structured credit problems, and said the Fed is working to educate banks based on the lessons learned from last year's credit crunch and the collapse of many mortgage products.

'We are conducting critical assessments of our own supervisory programs, policies, and practices,' Kohn said. 'Our intent is to identify opportunities for improving our own supervisory processes both within the current environment and as preparation for future supervisory challenges.'

Steps the Fed is taking include encouraging loan workouts through modifications, deferrals, extensions, and conversion to fixed rate loans. The Fed has also put out rules for comment aimed at improving lending standards, which he said will 'depend critically on strong enforcement.'

The Fed is also working to improve the Truth in Lending Act in order to ensure more information disclosure at the time loans are made.

Kohn said the Fed is also closely watching the credit card delinquency rate, which rose in the second half of 2007. He said bankruptcy rates also bear watching, since an increase there 'could be a harbinger' of delinquencies on other consumer loans.

http://www.forbes.com/afxnewslimited/feeds/afx/2008/03/04/afx4727887.html