Banking Woes Aren't Just Hitting Giants

Troubles at Wall Street behemoths are overshadowing ailments that will hit closer to home for most businesses.

By Renuka Rayasam, Associate Editor, The Kiplinger Letter

September 12, 2008

Hundreds of regional and community banks will fail in the next year or two. While struggling Wall Street giants make headlines, it's what's happening to Main Street banks that's the key to the financial well-being of most U.S. businesses. There's plenty of trouble there.

So far this year, 11 banks have gone belly-up. By year-end, a few dozen more will follow. And then the pace will pick up, hitting a peak in 2009 before edging back down in 2010. All told, figure that about 3% of the nation's 8,500 federally insured lenders won't survive. That's the greatest shrinkage the country has seen in two decades, though it's still less than the 1,108 of banks that crumbled between 1987 and 1992. The toll then amounted to about 8% of banks; there were considerably more banks to begin with.

The hardest hit areas are likely to be in California, Florida, Arizona and Nevada where property values skyrocketed and then plummeted. Georgia, too, will suffer, where building outpaced demand. And states such as Michigan and Ohio, where laid-off auto and other manufacturing workers haven't been able to maintain mortgage payments, are headed for trouble.

But woes won't be limited to those regions. Smaller banks that rode the housing wave upward, growing quickly and without diversifying their lending, are most likely to bite the dust no matter where they are located. And spooked regulators will sniff out troubles nationwide. Acutely aware of criticism by lawmakers that lending practices were allowed to become too lax, bank field examiners are now determined to prevent further implosions on their turf.

Regulators' overcautiousness is likely to make matters worse in the short run. Lending standards will come under the microscope, and federal regulators will insist that banks boost reserves and call business loans if collateral value has deteriorated. They'll crack down hard on situations that at other times might have been shrugged off as temporary blips. This time, they'll be unwilling to wait out some potential problems. And, in forcing the issue, they may deal a lethal blow to banks that might have otherwise survived.

Bank failures typically rise even after the economy starts to improve. Although faults start to appear not too far into the downturn, it takes a while for regulators to clean house. The Federal Deposit Insurance Corp. (FDIC) now has 117 banks on its so-called problem list. That's up from 76 last year but still lags reality. The fact is, examiners show up at banks only about once a year unless they have a specific reason to be more vigilant. So the number of banks on watch lists issued quarterly by both the FDIC and the Office of Thrift Supervision chronically underestimate the number of weak banks.

Most depositors needn't worry about bank failures. Federal insurance covers up to $100,000 per depositor at each institution. Larger accounts should be spread among banks. One convenient way to do so is to use the Certificate of Deposit Account Registry Service, which we wrote about in the Aug. 8, Kiplinger Letter.

Borrowers at smaller regional and community banks face rougher weather ahead. Even banks that are sitting pretty and in no danger of failing will be stingier. For example, they'll hike collateral requirements, set revenue benchmarks that business borrowers must meet and generally keep a tighter rein on those whom they lend to.

So start improving your creditworthiness now, particularly if you contemplate an expansion requiring borrowing once the economy starts to mend. Buff up your credit score. Get your books in apple-pie order. And cultivate your local banker before you want to borrow.

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