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Bank Weaknesses Show Slow Recovery; Minnesota Needs a Housing Plan

September 30, 2009 By Lee Egerstrom, Economic Development Fellow
Despite proclamations that the worst is over and that certain economic indicators suggest a recovery is at least in site, bank data assembled by state and federal regulators show Minnesotans face a long wait for a sustainable recovery.

Unless Minnesotans have a lot of money stashed under mattresses to fuel business start-ups and expansions, state- and federal-chartered banks will need to be the principal source of financing to get the economy rolling forward. But right now, banks are actually reducing their outstanding loan portfolios to improve their capital condition on their balance sheets.

This is what banks do in tough economic times - and are encouraged to do by bank regulators, said veteran Minnesota banker Larry Buegler. He was president of the St. Paul Farm Credit Bank, now known as AgriBank, when that agriculture lender returned from the brink of failure in the 1980s' farm financial crisis and is again consulting with bank groups on the current recession.

"The easiest way to improve your capital position is reduce your assets. It happens every recession," Buegler said.

This started two years ago when home real estate market turned soft and mortgages began failing. It has spread now to commercial and industrial loans as the recession has ripped through retailing, manufacturing and most sectors of the economy.

Data from the Federal Reserve System show this to be the case. Two graphics from the Fed, easily accessed through the St. Louis regional Fed bank show the total commercial bank loans and leases falling sharply in the first six months of this year. The portfolio of business loans - commercial and industrial loans - at the bank is shrinking even faster.


Data on third quarter banking conditions will be released in late November. There is no reason to suspect, however, that banks are back fueling business growth.

"Banking industry performance is - as always - a lagging indicator," said Sheila Bair, chairman of the Federal Deposit Insurance Corp. in an Aug. 27 release from the FDIC on second quarter banking conditions. For now, she added, "the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry's bottom line."

Commercial banks and savings institutions had a net loss of $3.7 billion in the second quarter. This occurred after the banks took one-time losses of $4.1 billion, primarily from writing down business and mortgage loans ($3.6 billion).

Amidst this, the FDIC raised its problem bank list to 416 banks. Bloomberg business news on Aug. 27 reported the number is the highest in 15 years and was a 36 percent increase in the second quarter.

Here in Minnesota, the state Department of Commerce regulators had its "watch list" of banks with "less than satisfactory" financial conditions more than double in 18 months from June 2007, from 26 banks to 50 banks.          

Banking Trends
The financial environment for banking progressively grew worse in the past year as loan quality spread from mortgages to commercial loans. Chris Serres, writing in the Minneapolis-based Star Tribune at the start of the year, noted that community banks now show stress previously associated with larger commercial banks and investment banks.

In his Jan. 18 report, "Loans threaten Minnesota community banks," Serres said the delinquency rate on commercial mortgages and construction loans increased 84 percent through the first three quarters of 2008.

On June 30, Ambar Espinoza reported for Minnesota Public Radio about the state Commerce Department's closure of Horizon Bank in Pine City and its acquisition by Stearns Bank in St. Cloud. State bank officials at that time said 65 state-chartered banks were on the watch list for stressed and troubled banks
On September , Jennifer Bjorhus wrote in the Star Tribune about the closing of Mainstreet Bank in Forest Lake and its takeover by Central Bank in Stillwater.

In her report, she noted that one in four Minnesota banks lost money in the second quarter, and the state Commerce Department's watch list of state-chartered banks had grown to 67 banks.

The FDIC announced the day earlier that Mainstreet was the second FDIC-insured bank in Minnesota and the 87th nationally to fail this year.

The trend continues. On Sept. 26, the St. Paul Pioneer Press reported in its Business section that the FDIC had issued "cease and desist" orders against three Minnesota banks at New Prague, Savage and Lewiston ("FDIC cites loan problems at 3 banks").

The three banks were told to maintain or boost capital levels.  
Home Values Guarantee Program
When the current recession started, most bank problems were centralized in urban areas where mortgages began toppling. That problem spread statewide and now catches rural banks that participate in business and commercial loans through larger banks.  

In an attempt to address home mortgage problems, Minnesota 2020 teamed with Buegler in January to propose a Minnesota Home Values Guarantee program patterned after a successful program Buegler used at the St. Paul Farm Credit Bank in 1987

Such a state program would put a floor under home values and stabilize both new home mortgages and restructured mortgages necessary to keep people in their homes and improve bank balance sheets. This would help both Minnesota borrowers and lenders while the banks work through their business loan problems.
Going Forward
Buegler said his thoughts have changed a bit since the housing guarantee program was first developed. "I thought then that we needed to stabilize the housing market so it wouldn't drag everything else down. Now, I believe we need to stabilize the banking business."

That hasn't diminished the need for the Minnesota Home Values Guarantee proposal. Rather, it may be imperative to shore up bank balance sheets and help bankers begin banking again - a requisite for turning the commercial and industrial economies around for a sustainable recovery.  

Creating such a state-guarantee program for the housing market remains one of the few things the Minnesota Legislature can do early next year to turn the state economy and free up bank capacity for business and industrial lending.

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