Report says specialized lenders not adequately hedged
By SAM GARCIA
4/15/2002

The biggest single near-term risk to insured institutions appears to be subprime consumer lending, according to a report by the Federal Deposit Insurance Corporation (FDIC). "Economic Conditions and Emerging Risks in Banking" was delivered to the FDIC Board of Directors last week.

In its announcement, the FDIC said that around 160 FDIC-insured institutions representing 6.3% of the industry's assets have been identified as having subprime consumer or mortgage loans greater than 25% of Tier 1 capital. The FDIC said this group has contributed disproportionately to recent bank failures and additions to the FDIC Problem Bank List.

The FDIC said that in addition to experiencing higher loan losses than prime lenders, subprime lenders have recently been noted by FDIC examiners and other regulatory sources to be using credit models that underpredict actual losses.

According to the FDIC, the report describes recent signs of a consumer-led recovery in the economy -- which may have begun in the first quarter. However, weakness in corporate profits, declining business investment, overcapacity in key industry sectors, rising commercial real estate vacancies, and high debt loads for consumers and businesses could dampen the economic recovery or even lead to another recession, the FDIC said.

The FDIC noted that recent growth was partly fueled by refinance mortgages that may not recur in the near term. The FDIC cited the Federal Reserve Flow of Funds data where the Fed said that volume of mortgage and consumer debt outstanding rose by almost $1.2 trillion between year-end 1999 and 2001.

According to Freddie Mac's recent economic forecast, refinances will fall from 2001's roughly $1 trillion level to about half that in 2002. However, it is likely that the drop in "cash-out" may not be as steep as the drop in overall refinances because of ongoing home equity-funded consumer expenditures that occur regardless of mortgage rates.

The FDIC said weaknesses in bank and thrift credit quality during 2001 were generally concentrated in states along the upper and lower Mississippi Valley that rely heavily on manufacturing and have experienced the longest period of economic weakness. However, during the second half of 2001, the FDIC said that the economic slowdown began to spread to metropolitan areas outside the central U.S. that have higher employment concentrations in information technology and financial services. Commercial real estate markets in many of these metropolitan areas deteriorated rapidly during 2001.

The FDIC also expressed concern over an increase during the late 1990's in banks with high loan concentrations of commercial & industrial and commercial real estate, which tend to fail at a significantly higher rate than other insured institutions.

Also of concern was the significant number of specialized mortgage lenders that have not hedged their interest rate risks even though the recent refinance wave has increased their concentrations of these loans. As a result, smaller institutions are more vulnerable to rising rates.

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