2009: The Year Lenders “Recapitalize to Survive”

If 2008 was the Year of Denial, 2009 will be the Year of Recapitalization.  How much recapitalization? Investment bank Keefe, Bruyette & Woods projects that United States Banks might need as much as an additional $1 trillion in capital, according to the April 24, 2009 edition of the New York Times.

If you’re an investor looking to buy distressed assets, or a fee service provider looking to help lenders to clear away the wreckage, this is important.  For a lender to sell a loan or the underlying real estate, a lender must write down the asset to its current market value – by definition its sales price – in order to close the sale of the asset.  When a lender writes down the value of its assets it must have a certain corresponding amount of additional capital in order to maintain its required reserves.  Otherwise the lender goes out of business. I don’t know many lenders who want to voluntarily go out of business, so writing down assets (including commercial real estate loan) by banks will have to wait until they are ‘encouraged’ to do so by the Federal Government. This explains why so many lenders with significant construction loan portfolios have acted like deer in the headlights, seemingly taking little action to work through their problem loans.  They can’t.

Until a lender has adequate capital to write down its loans and spend the money to market and sell its real estate, it can’t do either. This effectively stops a lender from taking any action – until the Comptroller of the Currency (if its a regulated lender) comes through and audits the books and forces the lender to raise capital or be taken over by another lending institution.

For several thousand lenders, happiness in 2009 and beyond will depend a great deal on how successful they are at the Darwinian process of raising new capital.  It will determine whether they are strong enough to survive as an ongoing institution or become absorbed by other, stronger lending institutions, as has happened already to a number of lenders (for example, Downey Savings and Pomona First Federal were recently acquired by U.S. Bank; Wachovia was acquired by Wells Fargo; WAMU was acquired by Chase; and Alliance Bank was acquired by Zions/California Bank & Trust, to name only a few). On May 26, 2009, Bloomberg News reported that as of the first quarter of 2009, the FDIC had classified 305 federally regulated banks as “problem” institutions, and went on to quote Gerard Cassidy, Managing Director of bank equity research at RBC Capital Markets as saying that, ”as many as 1,000 banks will go down from 2009 to 2012.”

So stay tuned and follow the capital.  When the smoke clears, many of the lenders that originated the loans will not be the ones that work them out, nor will they be the ones that live to lend another day.