San Francisco Fed says banks could weather a big hit to housing

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America's banks could largely weather a major housing downturn, a new Federal Reserve Bank of San Francisco analysis finds, and that includes thousands of smaller lenders that typically have higher exposure to real estate.

While Federal Reserve stress tests regularly check to make sure the largest lenders could handle a weak housing market, smaller banks aren't subject to the same sort of scenario analysis. In the event of the downturn, though, those institutions could matter: If they got into trouble, it could really hit local credit availability, for instance.

San Francisco research adviser Simon Kwan takes a look at where they stand, collecting bank-level financial statement data for smaller banks and using "severely adverse" stress test loss rates. These assume house prices fall 30 percent in the third quarter of 2019 and commercial real estate prices fall 40%.

Despite such a sharp setback, he finds that just 1.3% of the banking industry would be undercapitalized and 0.2% would be significantly undercapitalized, based on their real estate portfolios. Testing the banks' entire loan portfolios, institutions holding about 5% of the U.S. banking industry's assets would find themselves undercapitalized.

"Only a handful of small banks representing a small fraction of the industry would be significantly undercapitalized," Kwan writes. "The banking sector overall appears resilient enough to weather a steep decline in real estate prices."

Why? Banks' portfolios are concentrated in real estate today much as they were on the eve of the financial crisis, the analysis finds, but they have tightened their loan underwriting standards "a great deal" since then. Banks are also much better capitalized than before the housing crash.

Bloomberg News
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