It’s no secret that Americans are facing increased job loss, which causes them to not make their bills. As they become more and more delinquent on their monthly payments, financial institutions are eventually forced to take a loss in the form of a charge off. Delinquency charge offs are on the rise. According to the Federal Reserve Bank, statistics for all banks in the United States that are not seasonally adjusted (NSA) in the last quarter of 2008 had an average charge off for residential real estate loans of 1.62 percent, up 1.15 over the previous year. This figure considers recoveries that the financial institution may have made after the sale of a foreclosed home.
The real estate boom and demand for cash flow had many larger lenders deciding to offer loans that were 100 percent, or higher of the valued price. Some lenders even gave out loans at 125 percent of value because they assumed that real estate would continue to increase in value over the life of the loan. Unfortunately, that was not the case and so with many homes in the U.S. continuing to depreciate by nearly ten percent over the previous year, many homeowners are facing negative equity, cannot continue to pay their mortgage and face foreclosures. According to the National Association of Realtors, in the fourth quarter of 2008, there were 4.2 million homes for sale in the United States. If banks continue to foreclose and the supply on the market increases, it will cause further decline in the price of homes, which will force banks to lower prices past what the outstanding balance on the loan is. This will in turn create billions in write offs and a continued net loss. With so many lenders saying the words “net loss” more often than “income” and “profit,” it’s surprising that any financial institution in 2008 still has positive numbers.
Many community banks remain unaffected by the increasing trend in delinquent charge-offs. Two Washington, D.C. area banks, Annapolis Community Bank and Damascus Community Bank have both seen very little charge-offs in their lending department and both attribute this to cautious lending practices.
Because community banks do not have the resources of many national banks, they understood from the start that they couldn’t put their company at risk by not practicing conservative lending, which begins in the underwriting process. Many of their best practices in underwriting include examining a potential borrower’s housing payment against their current income to make sure that the debt to income ratio is low. Thoroughly examining credit reports for any delinquencies is important in trying to understand the borrower’s lending and spending habits. If the person has too much outstanding debt and has missed several payments on loans in the past, chances are that they are a creature of habit and will likely get themselves in over their heads. While many people stress that it is the borrowers’ responsibility to understand how much they can afford, it is also the responsibility of the lender to make sure that the loan is the right fit. Not only does this help avoid delinquencies in mortgage payments, should the person’s situation change, but it protects the lender’s assets and cash flow to try and avoid charge-offs.
The housing crisis has been on the forefront of every news publication over the previous year, however, residential loans are only the beginning of the problem. In the final quarter of 2008, the average charge off rate for consumer credit cards was 6.3 percent.
Many banks have responded by limiting the credit line that they offer. When a concerned customer calls in they try to work with them to lower the rate, if possible, which will help with the monthly minimum payment due. Lowering minimum payments so that a borrower can continue to make their monthly payments will extend the loan and if it does not get charged off, it will pay for the interest rate loss in time.
With many consumers facing such high delinquencies on their credit card debt, consumer spending is down. Even those that are still in a good financial position are becoming more frugal and only spending what they must. This trend is also exacerbated by consumers becoming cautious to make large purchases for fear that a company won’t be there in the near future should something go wrong with the product. When consumers stop spending, it hurts businesses that need to make their monthly sales goals in order to pay their real estate rents. When these businesses begin to close down, the corporation that owns the commercial real estate in that particular mall or area has trouble making payments to their lender and eventually if they cannot attract businesses that can pay the rents, they must either close down or allow a foreclosure and their lender faces billions of dollars in charge offs, as well as restricted cash flow while in the delinquency period.
The commercial loans trend is the most disturbing trend and one that will have an unforeseen impact on the future of lending. The commercial real estate loan segment of the statistics from the Federal Reserve Bank is at 2.14 percent, which is an increase of 1.7 percent over the previous year. This number will continue to grow rapidly.
It is imperative for financial institutions to start examining these trends and to take a proactive approach of talking to their borrowers in the commercial industry to try and renegotiate loans as soon as or before they become delinquent, so that it doesn’t get to the point where it must become a charge off. This will help to maintain a financial institution’s lending practices and prevent further charge offs.
