SF Fed President Yellen on Community Banks

From San Francisco Fed President Janet Yellen: Outlook for the U.S. Economy and Community Banks:

"Now let me turn to the business environment facing banks. The industry is going through one of the most difficult periods in modern times. ... Bank profits are down, loan delinquencies are up, and failures are climbing."

"Recessionary effects normally take some time to work their way through loan portfolios. So, even though I expect economic growth to resume in the second half of this year, banking conditions are likely to remain quite weak for another year or two."

"To date, the community banks under greatest financial stress are those with high real estate concentrations in construction and land development lending. Banks that liberally funded speculative housing and condominium construction, and those that funded land acquisition and development, have been hardest hit. Over 20 District financial institutions have failed since last year. The vast majority of them had high concentrations in residential construction and development lending. In fact, these banks had construction loans that averaged about 40 percent of their loan portfolio, well above the District average of 16 percent. Unfortunately, some banks that aggressively pursued these loans had weak appraisal and risk-monitoring systems."

"The next area of significant vulnerability for the banking system, particularly for community and regional banks with real estate concentrations, is income-producing office, warehouse, and retail commercial property. Market fundamentals in most western states are deteriorating. Vacancy rates are rising and rent pressures are hurting property cash flows. Office vacancy rates in both Boise and Portland are expected to reach or exceed 20 percent over the next year or two, the highest rates these cities have seen in many years. Retail shopping centers are struggling with falling occupancy rates and pressures to grant rent concessions. Property values are falling sharply across wide areas of the country, including the Pacific Northwest. Some analysts forecast that commercial property values could experience falls similar to housing of 30 to 40 percent."

"Our biggest concern now is with maturing loans on depreciated commercial properties. In many cases, borrowers seeking to refinance will be expected to provide additional equity and to have underwriting and pricing adjusted to reflect current market conditions. In some cases, borrowers won’t have the resources to refinance loans."