Southeast banking climate still challenging, bifurcated

Housing affects many economic sectors, notably banking. A robust housing recovery would invigorate the region's community banks. As a group, a rebound would bolster loan portfolios and generate loan demand. It didn't happen in 2010. Consequently, the Southeast's banking sector continued to lag its national peers. We'll explore specifics on that later.

The industry also became more bifurcated by size and by location. A gap widened between larger banks, whose conditions generally improved, and smaller banks, which continued to face significant concerns, noted Brian Bowling, a vice president in the Atlanta Fed's banking supervision and regulation department. The more diversified loan portfolios of bigger institutions began to stabilize. Thus, the banks could set aside less money to cover loan losses, which contributed to better earnings. Large banks have also found it easier to raise capital, something that remains a challenge for many smaller institutions. Nonetheless, for the first time since the crisis began to unfold, the Atlanta Fed supervision and regulation staff during 2010 began spotting signs of stabilization, if not improvement, at some large and small banks across the Southeast.

The year saw other positives. Nationally, more than 60 percent of the $389 billion in Troubled Asset Relief Program funds lent to banks was repaid by the end of 2010. The Fed's October 2010 Senior Loan Officer Survey indicated that 86 percent of the responding banks had stopped tightening standards on business loans.

Obstacles still abound, however. At the end of 2010, the Federal Deposit Insurance Corporation (FDIC) listed 860 "problem institutions" nationwide. In the Southeast, community banks suffered 10 consecutive quarters of net losses through the end of 2010, mainly because of heavy lending to residential real estate developers, according to Atlanta Fed banking supervision and regulation officials. Community banks—institutions with under $10 billion in assets—account for all but six of the 877 commercial banks headquartered in the Sixth Federal Reserve District. Absent a housing market recovery that absorbs much of the inventory of unsold homes, many of these banks with a heavy real estate focus will continue to face serious challenges, Bowling said.

To appreciate housing's effect on community banks, consider metropolitan Atlanta. At the peak of the boom, during 2004 and 2005, residential builders took out nearly 150,000 permits, according to the U.S. Census Bureau. In 2010, that number plummeted to about 14,000. At the top of the housing cycle, Georgia institutions were twice as dependent as the national norm on financing construction and development, as measured by commercial banks' share of total net loans and leases in construction and development, according to FDIC data. Not coincidentally, the Atlanta area suffered more bank failures than any other metropolitan area in the country—34 from 2008 through 2010. Few observers, Bowling said, believe the housing industry in the Southeast will return to its mid-2000s level soon. As a result, many community banks could be forced to find new sources of loan demand. Bowling added that it may be difficult for some banks to shift their focus from real estate development to other lending categories, such as commercial and industrial or small business lending. Those are different businesses that may require different lending and risk management skills.

Not surprisingly, lending for construction and development has already fallen dramatically. Since its peak in early 2008, outstanding construction and development loans in the region have declined by more than half, according to the Atlanta Fed supervision and regulation department.

Housing isn't the only concern for the region's banks. The costs of complying with regulation are rising after passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act. A consensus began to emerge among bankers during 2010 that, in order to afford those costs, an institution might need to be a minimum size, according to Atlanta Fed supervision and regulation experts.

Smaller banks face abundant challenges. But community banking has history on its side. The demand for local financial institutions—from small businesses as well as consumers—has endured through many previous economic downturns and outlived many dire predictions, Bowling noted.

Smaller banks face abundant challenges. But community banking has history on its side.