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As Loans Sour, Pace of Bank Failures Likely to Rise

Bloomberg says 150 publicly held U.S. banks are in danger of going under, weighed down by rising commercial real estate and credit card losses.

The number of banks with at least 5 percent of their loans rated as nonperforming, a dangerously high level, has doubled this year, the wire service reported. Not all banks with lots of bad loans ultimately collapse, of course. Still, such numbers suggest that the pace of bank failures is likely to rise, especially since in banking nonperforming loans are a lagging indicator of financial distress. Some 72 banks have failed this year, the most since 1992, according to the FDIC. For the most part, these have been smaller players. But the rot is spreading from smaller banks to bigger institutions.

The FDIC is reportedly set to shut down Colonial Bancgroup as part of a deal under which BB&T will buy the $27 billion-asset company. Other large banks with elevated ratios of nonperforming loans include Marshall & Ilsley, Synovus and Flagstar, Bloomberg said.

"As losses mount from nonperforming loans, bank managers at undercapitalized banks have to either raise equity, find a merger partner or hope for the best," said Linus Wilson, a professor of finance at the University of Louisiana at Lafayette, by email. "A bank that is undercapitalized tends to turn away good borrowers and seek out risky bets if unchecked by regulators. If the FDIC is doing its job, poorly capitalized banks cannot hope for things to improve for too long before their shareholders are wiped out."

One major risk for banks these days is the high vacancy rates for retail and office properties. Credit quality in this sector is degrading, while the value of these assets continues to sink, making it hard for customers to refinance. Yes, early-stage loan delinquencies are falling. But that won't reinvigorate banks overnight.

Scott Sprinzen, a credit analyst with Standard & Poor's, said in a report this week that "earnings pressures from this credit cycle will continue for at least a few more quarters as far as the consumer side of the equation is concerned."

On the bright side, a deal by BB&T to buy Colonial and other recent banking acquisitions suggests the markets are starting to heal. "As we saw with BB&T's reported assumption of the branches of Colonial, a failing bank's misfortune can be a surviving bank's profit," Wilson said.