Asset sales and writedowns are a top priority for many banks right now — but these are only first steps.
In the long run, part of eliminating concentrations in one loan category, such as real estate development, or in a particular geographical area, must include lending elsewhere.
The problem is, there are only so many safe alternatives — and everyone is going after them at the same time.
Truly diversifying into other lending sectors such as consumer or commercial and industrial loans will be challenging for most banks because larger banking companies dominate these business lines.
And there will be temptations to give up.
Many local economies revolve around real estate growth and depend upon banks headquartered there to finance it, analysts said. Once the economy revs back up and real estate development resumes, observers speculate that real estate concentrations will resume their creep upward.
“In the West particularly, real estate is a big part of the market, and so it’s hard to avoid having some concentration in that,” said Joe Morford, analyst at Royal Bank of Canada’s RBC Capital Markets. “Plus, there’s been such consolidation here over the years that the big banks really dominate the consumer market. So regional and community banks have to find opportunities with business customers and real estate developers.”
As an example of reducing concentration in a particular market, the $5.5 billion-asset Central Pacific Financial Corp. in Honolulu has reduced its California residential construction loan portfolio by 90% since June 2007, to $35 million. Two years ago, its exposure there was 8% of its total loans; at June 30, it was just 0.9%.
Synovus Financial Corp. in Columbus, Ga., has been cited by many analysts as one of the most aggressive in reducing its concentrations of risky loans. Since the fourth quarter of 2007, the $34.3 billion-asset company has cut its residential construction, development and land acquisition portfolio 36%, to $3.8 billion. Such loans now make up 14% of Synovus’ total portfolio, versus 22% in late 2007.
“Our tolerance for the level of risk in residential construction is not what it used to be,” said Richard Anthony, Synovus’ chairman and chief executive. “We will continue to finance some builders and developers. However, we’ll be very selective, and it’ll be on a smaller percentage basis going forward.”
In particular, Synovus would like to make more commercial and industrial loans and consumer loans, Anthony said. At June 30, such loans made up 41.3% and 15.6% of its portfolio, respectively, while commercial real estate loans made up 43.1%; the company ultimately would like these percentages to be 45%, 20% and 35%, respectively, he said.
But analysts said such efforts will be difficult.
Banks will probably try to increase their commercial and industrial loan portfolios, but regionals and larger community banks still face competition from the Wall Street commercial paper market, and smaller banks might not have the right expertise on staff, said Jeff Davis, an analyst at First Horizon National Corp.’s FTN Equity Capital Markets.
Still, there is room for many banks to beef up their C&I lending, particularly to smaller customers overlooked by large banks and Wall Street, said James Rockett, a co-chairman of the financial institutions group at Bingham McCutchen LLP in San Francisco.
But when the economy resumes running in high gear, it may be particularly hard for banks not to reach high concentrations again.
“In a declining, slow-growth asset world, the way you survive is by segmenting and defining exactly the classes of assets you want to put on your balance sheet,” said Rick Spitler, a managing director at Novantas LLC. But when things are booming, “it’s hard for banks to walk away from profits to be made, and it takes a bank with extraordinary discipline not to concentrate in geography or asset type.”
The risks of higher concentrations may be mitigated if regulators’ call for additional capital, said Mark Tenhundfeld, director of the American Bankers Association’s regulatory policy office. Banks may also stress-test their overall portfolios for concentration risk, incorporating several macroeconomic scenarios in the tests.