Still talking about those pesky legacy loans

June 29, 2009

For all the stabilization in the financial markets and talk about the ECB and Federal Reserve weighing exit strategies from the massive amount of stimulus they’ve pumped into the system, the U.S. still hasn’t come up with a viable solution for the toxic plague on bank balance sheets. Though markets don’t seem too bothered since the big banks have been able to raise tens of billions of dollars, it’s the fate of smaller banks that are exposed to construction and development loans that are a real worry.

WSJ reports that government’s grand plan to address the toxic legacy issue, the Public-Private Investment Program,  PPIP, has stumbled and lost momentum, which could have implications for the economy’s revival. And since the program has been revamped, it’s small banks that are likely to suffer the most.

The slimmed-down program will focus not on bad loans, but on toxic securities, which are a problem for a relatively small fraction of the nation’s banks. That is bad news for hundreds of smaller banks burdened with growing piles of defaulted loans. These banks are less able to tap capital markets than their larger rivals, so they have been eager for U.S. help unloading loans as a way to bolster their capital cushions. Many of them can face big problems if just one or two large loans go bad. Seventy banks, most of them community institutions, have failed since the start of last year. Analysts are bracing for hundreds of lenders to collapse in the next few years.

Because these lenders often play key roles supporting their local economies, taken together, they are important to the financial system and to a U.S. economic recovery, says Kenneth Segal, senior vice president at Howe Barnes Hoefer & Arnett Inc., an advisory firm for small and midsize lenders…

Scott Romanoff, a Goldman Sachs Group Inc. managing director, has referred to the current effort, PPIP, as “the greatest program that never occurred,” because it “created confidence in the markets so banks can raise equity capital.”

In recent weeks, markets have lost some vigor amid renewed concerns about the economy. That could make it more difficult for big banks to raise additional capital. Banks also could face further losses as bad assets decline more in value.

The FDIC reported Friday that five more banks failed, bringing the total to 45 this year.

Though the likes of Goldman Sachs and JPMorgan would like to put the credit debacle behind them, the issue of toxic loans and securities means the credit crisis is one that will keep on giving in the years ahead.


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