Today at TILE we talked about how people are saving more, yet banks are continuing to go out of business. If people are putting more money in banks and banks are lending less, why are they still failing? Shouldn’t more money in the banks mean a more stable economy?
You’d think extra savings would make sense, but so far this year, 98 (mostly small) banks have failed. That’s because the health of a bank isn’t only determined by the amount of money people save or how much it has locked away in the safe. It depends on a few key factors: the quality of the bank’s loan portfolio (what they lent to other people or businesses in the past), the amount of money they can currently loan to generate new business (which creates revenue or earnings), and, yes, the amount in the bank.
A bank’s loan portfolio is basically the assets on the bank’s balance sheet. The loan decisions made in the past can either prove to be good ones or bad ones. Let’s imagine you spent some money on seeds to plant a vegetable garden, with the expectation of selling the vegetables at the end of the season for a profit. Towards the end of the summer, you realize that the seeds were bad, or maybe you just didn’t take proper care of them. You try to salvage them, but unfortunately, no matter how much fertilizer and water you throw on, a bad seed is a bad seed – and you wind up losing money. Without any revenue or earnings, you can’t go out and grow your vegetable business and you may even see your plot of land absorbed by a more experienced gardener!
This is how a lot of small banks feel right now. The difference is that the “bad seeds” in their case are really bad loans for commercial real estate development (think about all those empty strip malls). According to Foresight Analytics, half of the industry’s $1.8 trillion in commercial real estate loans are held by small and medium sized banks – and those banks represent just 15% of the total banking industry. In other words, the small banks hold a very high percentage of bad seeds.
Another important factor is the amount of money banks can loan out in order to earn revenue. Going back to our garden analogy, let’s say that in the past you could plant one seed every inch; but today, the garden authorities (or regulators) are saying that in order to preserve seeds you can only plant one every five inches. In financial terms, regulators are requiring banks to hold greater capital reserves (money for a rainy day) and are thus reducing the amount of money they can borrow. In the past, a bank may have had $10, and regulators only required them to hold onto $1 in case of an emergency. At that time, banks also had the ability to leverage their money 20x. That meant they could generate $180 in loans ($9 multiplied by 20). Today, banks may have $10 in capital but need to hold onto $3, and can only leverage the money 10x. This means they can only generate $70 in loans. With bad loans (or “bad seeds”) on the balance sheet they are mostly focused on “getting back to even” – not focused on lending to new businesses or generating future revenue.
So what does it mean for the TILE Community? Well first, if you and your financial advisor determine that saving (or growing) your money is a good idea, then do it! At the same time, be conscious of the amount in each account (is it more than the $250,000 maximum insured against bank failure by the FDIC?), where it is (a large or small institution), and the expected return. Second, if you are looking to get a loan (and it doesn’t have to be for a vegetable garden), it may be tough out there. Since many smaller banks are overwhelmed by dealing with so many bad loans, they’re still hesitant to lend. But if you have a project or a business idea you really believe in, be persistent. Your time and energy may be the best investment of all.
- Amy