The towering casinos that line the strip have long defined Las Vegas. This decade, Sin City became known as a boomtown as well, its population surging 30 percent between 2000 and 2006, to 1.8 million people. The ensuing spike in housing demand, combined with easy-to-come-by mortgages, fueled a building boom and a steep run-up in home values, with the median price ballooning from $129,000 to $295,000.
What came next - the subprime crisis, credit squeeze, housing slump and resulting economic fallout felt by much of the country - has played out with particular vigor here. Home prices have fallen by 30 percent, and most predict still have a ways to go. Large housing developments are sitting empty or half-completed, and foreclosures have soared: In November, RealtyTrac listed 17,408 bank-owned properties for sale. To make matters worse, tourism, the economy's main driver, is down.
The local banking community is feeling the heat. Three banks have failed so far, and more are expected to go under before it's done. The survivors are increasingly under pressure. Sun West Bank, headquartered just two miles west of the strip on Flamingo Road, is still turning a profit, CEO Jackie DeLaney says, but it's been halved. Non-accruals and past-due loans, driven by real estate development loans, have jumped to 4.98 percent of the $450 million-asset bank's portfolio, from 0.91 percent five quarters earlier, and could rise more.
DeLaney gets a vivid reminder of the troubles each day when she arrives at work: imperiled homeowners spilling into the hallway from a bankruptcy attorney's office next door. She notes many commercial clients are struggling to make a go of it, as well. "We don't even do mortgages, but there's a ripple effect that's affecting all of us," she says. "We're clearly in a recession here, and it's been caused by housing."
The question on everyone's mind here - and throughout most of the country - is how do we get out of this mess? As the failures of so many big financial institutions and the recent flailing of government policymakers illustrate, breaking free from the present financial crisis won't be easy. Most, however, agree with former Federal Reserve Chairman Alan Greenspan, who told a congressional committee in late October that stabilizing home prices is "a necessary condition for this crisis to end."
That makes intuitive sense. Sixty-eight percent of households have some sort of housing investment, while home construction and all that's tied to it accounts for nearly 20 percent of GDP, according to Fannie Mae Chief Economist Doug Duncan.
The problem is, it will be very difficult, if not impossible, for housing to rebound if banks aren't willing to lend. And current statistics indicate that they're not - at least not in any broad, meaningful way. Many are so scared or preoccupied, they're steering totally clear of residential real estate. "There's too much uncertainty ...a general lack of confidence based on the over-leverage of both households and institutions," Duncan says.
What we're left with is an ugly cycle - a rut, if you will - where banks foreclose and slash prices to dump those properties. Home values get depressed further, leaving more homeowners underwater on their mortgages. They conclude it makes more sense to simply walk away than try to keep up, leading to even more foreclosures. "It's a vicious circle," says Richard DeKaser, chief economist with National City Corp. and a housing expert. "Falling housing prices and a deteriorating economy lead to rising foreclosures, which lead to larger loan losses, which makes banks more stingy, which contributes to further deterioration."
It's a maddening Catch-22 that's being contemplated by bankers and policymakers across the country. The federal government's $700 billion bailout is meant to grease the skids by buying bad loans off of banks' books and providing lenders with the capital needed to begin lending again. It's a good idea and might yet work, bankers say. But even with the government help - and demands from Washington to open the loan spigots - no rational banker can afford to catch a falling knife.
Some banks are using the capital injection to address foreclosures. In November, JPMorgan Chase announced plans to use its $25 billion in government funding to modify terms on some $70 billion of mortgages, held by 400,000 households, in its portfolio. But that's the exception. As banks continue to tighten underwriting standards - demanding higher loan-to-value ratios, more documentation, higher FICO scores and the like - originations are down sharply from last year, and are expected to fall further in 2009, Duncan says.
To be sure, ideas to jumpstart the market are being kicked around. One would attempt to get around roadblocks in the securitization market by establishing standardized, government-mandated resets on loan terms when home prices in a given market fall, say, 20 percent. Getting investor buy-in, however, could be difficult. Another envisions the government making "mortgage replacement loans" at lower costs to keep borrowers in their homes. A third, promoted by the FDIC, would encourage banks to rework troubled loans by providing a partial federal guarantee for losses on loans that meet specific criteria.
Most of these efforts aim to head off the rising tide of foreclosures and stabilize the housing market through a "combination of asset writedowns by lenders and renegotiated terms for borrowers with government support," DeKaser says. The election of Barack Obama as president is certain to lend a greater sense of urgency to the quest for a solution. But would any of these ideas really work? Fannie's Duncan doubts it. "The market is relentless" in seeking out a price equilibrium for housing, he says, and it's still a ways off. Attempts to create a floor above that price will only delay the inevitable, and could actually lengthen the crisis. "Eventually, we'll get to that equilibrium price. It'll just take time."
Some recent statistics provide a sobering overview of the market. At the end of the third quarter, vacancy rates for existing homes stood at 2.8 percent nationally, compared to 1.8 percent in 2005 - a 55 percent increase, according to the Census Bureau. In June, the S&P Case-Shiller national index of home prices stood 18 percent below its 2006 peak. Economists from Goldman Sachs project another 15 percent slide before we hit bottom. DeKaser, who employs a different methodology, says prices nationally have dropped just six percent, but agrees there's more to go. "We're about two-thirds of the way through," he says. Noting the growing recession, Duncan is only willing to concede that we're "over halfway" to the bottom.
The news on housing starts, a key economic driver, might be even worse. Ivy Zelman, CEO of Zelman Associates, a firm that tracks real estate sales, has predicted that new home construction will fall to 750,000 units in 2009 - 21 percent less than 2008 - but told attendees at a recent homebuilders conference that it might actually fall below 600,000. In 2005, the figure was more than two million. "I think it's going to be really bad. That's my gut, and I'll tell you why," she said. "It's because we can't get funding for builders."
Construction and development (C&D) lending declined in the second quarter for the first time in 11 years, according to the FDIC, but it's tough to blame bankers for tightening the purse strings. The industry's net charge-offs on C&D loans soared by 1,228 percent in the second quarter, versus a year earlier, while 6.08 percent of banks' $627 billion in such loans - roughly $38 billion - were classified as non-current.
The same dynamics hold for mortgages, where charge-offs ballooned by 822 percent, and a recent Mortgage Bankers Association survey found 2.75 percent of all mortgages in foreclosure - double the rate of a year earlier. While many banks have continued underwriting home loans for their best clients, that's not nearly enough to sop up what the Commerce Department says is a 10.4-month supply of homes, (six months is considered the top end of "stable").
In Las Vegas alone, notes Dallas Haun, CEO of $4.5 billion-asset Nevada State Bank, some 30,000 homes are on the market - about double the inventory of three years ago. "And today, the credit products that fueled the '05-'06 explosion - the low-doc, no-doc, subprime, interest-only loans - don't exist," he explains.
The price implosion explains as well as anything the troubles of big national lenders. Ron Martin, CEO of $476 million-asset Oak Valley Community Bank in Oakdale, CA, just outside of Modesto, blames competition during the boom from the likes of Washington Mutual, IndyMac Bancorp and Wachovia - all since failed or acquired - for fueling an unprecedented run-up in home prices. "A lot of people who shouldn't have gotten loans got them," Martin says. "Those banks paid the price."
Regional and community bankers bought into the frenzy, too. Silver State Bank, a $1.8 billion lender in Henderson, NV, focused almost exclusively on development loans, and for a while ranked as one of the fastest-growing banks in the country. But the string ran out in September, and the FDIC seized Silver State, selling its deposits and five branches to Haun's Nevada State, a Zions Bancorp subsidiary. "It was purely a real estate bank, just rocking and rolling, booking deals and making fees," Haun says.
While data show that places like Texas and parts of the Midwest have barely felt a tremor, (or in a few cases, even seen home values rise), once high-flying locales such as southwest Florida, Phoenix and southern California - not to mention parts of the industrial Midwest - have witnessed devastating price drops that lie at the root of the banking industry's present woes.
Signs of the financial apocalypse are in ample supply in those bust markets, fueling a sense of fatigue among bankers. Six markets in California's central valley rank among the top-15 nationally in home-price declines, according to home-price tracker Zillow, with Merced and Stockton both off their highs by nearly half. Prices on lots valued at $110,000 only three years ago have cratered to $40,000 today. Things are so bad, "60 Minutes" recently came to the region for a segment on the bust; financier Donald Trump looked at saving one big Fresno development, only to conclude it was hopeless. "The only thing selling now are bank-owned properties and short sales," Martin says.
Oak Valley is still making money, but did finance two Stockton land purchases that have gone south and had to be written off. "It's scorched earth in Stockton - ground zero," Martin says. The "only place worse," he adds, is Merced, home to Capital Corp. of the West, which lost $20 million in the second quarter and has seen its share price drop from a $34 high in 2005 to $2 today. CEO Richard Cupp, a southern California turnaround expert who recently took the helm, didn't respond to interview requests, but has hired Keefe Bruyette & Woods to explore strategic "options."
The story is much the same in Naples, FL, where prices have dropped 36 percent. Neighboring Lee County, home to once-booming Ft. Myers and Coral Gables, now has more than 23,000 residential properties in foreclosure proceedings, according to Bill Valenti, CEO of $340 million-asset Florida Gulf Bank in Ft. Myers. "They've had to bring back retired judges and expand the hours of operations for the courts to handle the volume," he explains.
With so many homes abandoned, vandalism is on the rise. "They're ripping out air conditioners, brass - whatever they can take," Local bankers aren't faring much better. Riverside Bank of the Gulf Coast, a big real estate lender, fired its president, closed three branches and recently was sold to a group of Brazilian investors after losing $19.1 million in the first half of the year. "Everybody's feeling beaten down, hoping for a bottom" to real estate prices, Valenti says. "But we sell 2,400 houses in a good month, so you do the math."
In Las Vegas, several local banks piled into either residential mortgages or development deals. When liquidity began to tighten, many began turning to high-priced brokered deposits to fund their balance sheets. Others have employed a Vegasesque twist, having touts walk the streets with sandwich signs advertising five percent rates on CDs. "It's pretty negative, pretty gloomy out there," Haun says of the banking community's mood.
Customers are worried, too. Passenger traffic is down at McCarran Airport, hotel occupancy is down and unemployment has risen to 7.4 percent. Bank employees say it's not uncommon for friends to ask questions about FDIC insurance - something unheard of until this year. When IndyMac failed in July, Nevada State's call center registered 400 calls a day from jittery depositors. Haun himself became a regular on local newscasts, offering assurances on bank stability.
We're not done yet. DeKaser figures that markets ranging from Atlantic City, NJ and Honolulu to Miami are still significantly overvalued. The biggest risk could lie in the Pacific Northwest, where DeKaser says home prices in most markets - including Seattle and Portland, OR - have 20 percent or more to fall before they are fairly valued. "The Northwest is the next shoe to drop," he says. "Those markets seemed to be getting more and more overvalued even as others were correcting."
Ray Davis, CEO of $8.3 billion-asset Umpqua Holdings in Portland, concedes that some markets are "overcooked and overbuilt." But he also argues that most of the region looks stable. "I don't buy it. There are pockets of overvaluation, but it's not anything like what we saw in California."
Davis also notes that some locales, such as Sacramento, are showing nascent signs of improvement, mostly in rising sales of foreclosed properties. That's encouraging, but things are likely to get worse before they get better, experts say, with declines continuing in those hard-hit markets - and nationally - through 2009. Fannie's Duncan doesn't foresee a bottom until early- to mid-2010, at the earliest.
Smart bankers are walking a tightrope as they manage the challenges, trying to strike the right balance between shareholders, regulators, customers and the community. In California, Martin knows several of his rivals are in trouble. Even so, local bankers are maintaining their poker faces. "The last thing a financial institution can do is say, 'This sucks. I hope we make it,'" Martin says. "You don't want to pierce the trust of customers and the community."
Operationally, most are beefing up workout departments, trying to keep problem loans under control. Umpqua employs a "special-asset" unit, separate from the lending department, which attacks troubles early in the process. Many say they've had to get tough with clients who aren't keeping up, foreclosing, marking down values on their books and then selling the homes themselves or to vulture funds that pay 30 cents on the dollar. Others figure prices are so low, they're better off simply holding the properties themselves and wait for a recovery.
But most are willing to exhaust all available avenues before taking possession. "I'm telling clients, 'Give me something - anything - to work with, and we can rewrite this contract.' It's only when they say 'no' that we foreclose," explains Haun, whose bank recorded a loss in the third quarter. "I'm thinking long-term. This is a small community. If you screw somebody or are unnecessarily tough with them, they'll remember when we come out of this and tell their friends."