Saturday, August 22, 2009

Small bank, big bank - the difference is real estate exposure

As a follow-up to our previous post, on failures of small banks, here is an interesting fact: small banks had significantly higher exposure to real estate than large banks.

There is a general misconception out there that the large banking institutions have been responsible this financial crisis by taking excessive risks, while the "main street" banks have been relatively prudent. This assumption turns out to be completely wrong.

Using data from the Fed, we looked at the ratio of real estate loans to total assets for large and small domestically chartered US banks (for reference: FRB data code H8/H8/B1026NLGAM over H8/H8/B1151NLGAM). For large banks we also included mortgage-backed securities (code H8/H8/B1303NLGAM). The result is actually quite shocking:

Source: Federal Reserve Board

At the peak, almost 50% of small banks' balance sheets was in real estate loans. Large banks never got close to those levels. Furthermore small banks' real estate related portfolios have not decreased significantly - still over 45%. It's no surprise therefore that small banks are not lending and Meredith Whitney is predicting 300 additional small bank failures.

Small banks used depositors' money and the taxpayer's guarantee to lend against real estate without much consideration for diversification. This is indeed bad news for the FDIC and the taxpayer. What's ironic about this situation is that TARP funds will likely be repaid - it is even entirely possible that the Treasury will end up making money on TARP (with dividends and warrants). However the bulk of taxpayers' money to bail out the FDIC deposit insurance fund (FDIC is asking Congress for a half a trillion credit line) will probably never be recovered.