Small Enough to Fail

By Covering Business     December 15, 2011

By Nish Amarnath
Columbia Journalism School, C’12 

Central Progressive Bank, a 17-branch regional bank based in Lacombe, La., fought hard with federal regulators to prove it could overcome its bad real estate loans in Florida. But not hard enough.

Last month, Central Progressive became the ninetieth financial institution – and the first in Louisiana – to shut down its operations in 2011. The closure cost the Federal Deposit Insurance Corporation an estimated $58 million.

Over 400 small and midsize banks have been forced to close shop since 2008. Although the national pace of these failures has moderated this year, suggesting that the worst of the economic downturn is behind them, some regions have seen their local banking industries completely transformed.

Georgia, Florida, California and Illinois have seen more bank closures than other states. Since 2007, more than 40 banks have collapsed in Georgia alone.

Economists say these states have been hit particularly hard by the decline in real estate prices and falling local incomes. The price slump has affected lending activities and local business conditions, contributing to a lull in the economy.

The federal home-buying tax credit boosted housing prices across the country last summer, but the credit expired in April. Now, foreclosures, depressed consumer confidence and a surfeit of unsold homes continue to saddle home prices. The demand for mortgages has fallen, leading to a sustained depression in asset prices and exacerbating the losses of smaller banks.

Mortgage defaults pose another problem. “An increasing number of defaults during an economic downturn is inevitable,” said Alejandro Sanchez, president and CEO of the Florida Bankers Association.

Smaller banks have been facing financial troubles because of their heavy reliance on commercial loans. The Moody’s/REAL Commercial Property Price Index suggests property values have fallen by 49 percent since the index peaked in October 2007, weighing on lenders.

Smaller financial institutions have less bandwidth than larger banks to cope with a mounting number of mortgage defaults because they carry smaller loan loss reserves. At the same time, new reserve requirements are putting pressure on them. As a result, many do not have sufficient capital to overcome their losses.

Bigger banks, which benefited from the government’s Troubled Asset Relief Program, have been faring better. The collective asset base of Bank of America, JPMorgan Chase, Citigroup and Wells Fargo has risen by 92.5 percent since 2007. All four banks hold assets that are worth $7.7 trillion today, up from less than $4 trillion in 2007.

The assets of larger banks have risen at the expense of the smaller ones. Small and midsize banks, which struggle to operate on their own, have become takeover targets.

The median total assets and deposits of acquiring institutions were $14.7 billion and $7.8 billion between January 2007 and December 2010, according to the Federal Reserve Bank of Saint Louis.

Bigger banks have had an advantage all through the credit crisis. Given how interconnected they are, federal officials say they cannot be allowed to fail because their closure would be disastrous to the economy. Many agree that these banks are in business today largely because they received government bailouts.

Some economists say that the bigger banks were rescued mostly for the mortgage securities they had in their books. Mortgage securitization typically expands the leverage of bigger banks. However, it could have strong implications for the broader economy today.

“Securities are subject to the vagaries of the market, and the market that we presently see is very volatile,” said Fred Sommers, lead partner of Boston-based capital market consulting firm Basis Point Group. “The current market has been pushing down the value of securities. Hence, banks that are securitizing their loans face unrealized losses that affect their net equity and capital.”


This article was written for the Columbia Journalism School’s seminar on business and economics journalism in the fall of 2011.

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