News & Press
Tom Hoban's Column
Culling the ‘bank herd'
Published: Monday, March 1, 2010
Culling the ‘bank herd' necessary before county's financial market finishes long period of adjustment
By Tom Hoban
“Okay, boys, let's get to brandin', castratin', and inoculatin'!” he shouted. “Those four over there don't need to be in the mix. They're scrawny. Not worth the trouble. I'll feed ‘em to the dogs at the end of the day”.
You had to be at least fourteen and “strong enough to lift a bale of hay” to win a spot on my uncle's ranch hand team in Ellensburg.
For suburban kids like my brother and me, it was a rite of passage. Those instructions started the annual ritual every spring that continues today.
We learned quickly that a herd with scrawny calves was a sick herd and some simply weren't going to be allowed to live.
Living, of course, meant being subjected a pro-wrestling like tackle-and-pin effort by a couple of teenage boys followed by grown men with de-horning tools, a castration knife, and a branding iron, like something from a John Wayne movie, diving in through the dust to do their thing on the pinned calf. In thirty seconds it was all over, then we tackled the next one. Later that day, the dogs were fed the scrawny ones.
“Only four out of two hundred this year,” I recall my uncle saying one year as if to suggest it was a very healthy herd over all.
The parallel between culling the herd and the situation with our community banks today is interesting to think about. According to the State's Department of Financial Institutions, Washington's banks had the highest percentage of commercial real estate loans on their books of any state in the country as we entered this year.
More than Michigan, more than Arizona, more even than struggling California. Over 80 percent of the troubled real estate loans were linked to incomplete housing developments of one kind or another.
Snohomish County is particularly flush with our share of these problem loans, with areas in the northern half and eastern end of the county being particularly heavy with properties held as collateral against loans that borrowers no longer can service because the housing market values have dropped below costs. Most of these loans are housing developments that never got to completion before the market collapsed more than a year ago.
Our herd is sick.
That's a problem for banks because loans in some degree of trouble require that the bank set aside valuable cash as a loan loss reserve just in case things get worse. As the grade of the loan works its way from an A to an F, the amount of loan loss reserves the bank must tuck away increases.
The diagnosis for banks with high concentrations of troubled real estate loans getting well in this environment isn't easy to see. Many face a fate similar to the scrawny calves.
That's because banks with these troubled properties, or borrowers forced to sell undeveloped land, into this kind of seller-heavy and buyer-light environment don't usually get top dollar for them.
Someone will have to eat those losses. Many work to sell assets without steep discounts. But the pipeline of troubled loans behind these is building at a faster pace than the sales. Something has to give.
More often than not, the FDIC — like the rancher — will step in and take over a bank to clean the situation up.
The Horizon Bank take over in January was a textbook example: far in advance of the Friday evening shut down of Horizon that allowed the doors to open Monday under Washington Federal's flag, the FDIC had quietly made a deal with Washington Federal, a healthy bank, to take on Horizon's deposits and troubled loans.
Banks love the deposits, of course. To incentivize Washington Federal to take on Horizon's troubled loans, though, the FDIC steps in to insure the difference between the loan amount owed and the current appraised value.
This mechanism is important to understand because once the FDIC steps in like this, the healthy bank has every incentive to sell the collateralized properties at current market value. Inoculated now from the disease of these bad loans, the healthy bank often takes the properties to market immediately. It's an orderly culling of the herd. And it works.
From a market standpoint, it's also a necessary activity. These FDIC-led moves will strengthen the herd and allow the stronger banks to survive.
Healthy banks make loans and getting lending rolling again will trigger the recovery of the market as pricing settles into a sweet spot once the collateralized properties stop entering the market in big chunks.
In the mean time, the value of residential land will very likely drop even more in Snohomish County this year with areas of north and east Snohomish County carrying the brunt of the adjustment until the FDIC has finished culling the herd.
Tom Hoban is co-owner of the Everett-based Coast group of commercial real estate companies, specializing in commercial real estate management, sales, leasing and investment. He can be reached at tomhoban@coastmgt.com, 425-339-3638 or www.coastsvn.com.