Forecast: Many banks will be loath to lend in 2010

Last year through November, 124 banks closed throughout the U.S. Estimates are that nationwide, 500 banks may be closed before the banking crisis is finished. In Washington, which had 104 banks and thrifts at the start 2009, three banks have since been closed, including one in Vancouver.

o Banks will repair and reduce balance sheets rather than lend and grow in the coming year.

o Banks with capital and cash will acquire what is left of banks that die.

o Mortgage rates will be low, but it will be tougher to qualify for a loan.

o Business loan pricing based on the prime rate should be stable for the next year, as the Fed focuses on stimulating the economy, and thus managing low interest rates.

Everybody remembers how giant Seattle-based Washington Mutual was forced to be acquired by J.P. Morgan Chase in late 2008. Industry insiders think another 25 to 35 Northwest banks could be among the more than 500 that will close nationwide.

Banking has become a game of staunch defens, and cautious offense. For banks, defense means strong liquidity (cash), more capital and a heightened focus on management of credit and other risks. Core customer deposits provide the best source of cash for banks, so expect banks to focus on deposit growth — especially business and checking accounts.

Since loans generate income, banking offense equals loan growth. But when borrowers stop paying, loans produce losses, which reduce income, capital and ultimately, liquidity. Without income and capital, banks suffer. When losses persist, liquidity disappears. Without liquidity, banks die.

Here are some of the trends that will likely be seen in in 2010:

• Banks will repair and reduce balance sheets rather than lend and grow in the coming year.

Around the country, bank management is focused upon survival. Careful attention is paid to maintaining adequate liquidity, and protecting or building capital. Fundamentally, banks need to continue making loans, because this is what produces revenue, which increases capital. Typically, banks will carry more capital than required by regulators, thus holding a capital “cushion.” This way, they can continue to make new loans. This, along with a loss allowance, also allows the bank to withstand minor loan losses, should they occur. In the current crisis, with losses from loans much higher than normal, bank regulators are requiring banks to hold more capital than ever before. Banks can sell more bank stock to increase capital, but capital ratios are also increased by shrinking the loan portfolio. Increased capital ratios will please bank regulators. Unfortunately, this might require banks to reduce the lending it would normally do in the community. That would seem to be at odds with attempts to stimulate the economy. It is all a delicate balance. Bank regulators are in no mood for any weaknesses. Banks with capital and cash will acquire what is left of banks that die.

• Credit will be cheap but not easy to get.

The government has intervened in the banking, lending and borrowing processes, probably to an extent never before seen. The Federal Reserve has pushed short-term interest rates to generational lows, with the federal funds target rate at 0 percent to 0.25 percent. Furthermore, the government has pumped some $700 billion of capital into various programs, including more than $200 billion into selected banks through the Capital Purchase Program. Large insurance companies have gotten a share. We have seen $8,000 tax credits for first-time home buyers’ extended through April 30, and to include $6,500 in tax credits for certain existing and former homeowners who move to a new home.

Also, the Home Affordable Modification Program is designed to reduce delinquent and at-risk borrowers’ monthly mortgage payments, for as many as 7 to 9 million homeowners, making their mortgages more affordable and helping to prevent the destructive impact of foreclosures on families, communities and the national economy.

These programs, policies and strategies are intended to circumvent economic disaster, and to encourage commerce, which could help jump-start the economy.

• The consumer is stuck in the middle. The guy who is supposed to pull all of us out of this economic quagmire, the consumer, is struggling. The consumer normally accounts for two-thirds of our economy. Does the consumer have the firepower to save us? Unemployment is more than 10 percent nationally, and the average duration without a job is now about 26 weeks. Housing prices have slowed their decline, but for how long, and what happens after the government programs expire?

Foreclosure rates and bankruptcy filings are increasing. The retirement nest egg has taken a beating, although, stock indexes have improved, replacing some of the lost wealth in savings plans and 401(k)s.

The consumer is strapped if he has a job. He is depressed if he has no job. He has spent what he could, using government incentives to buy cars, appliances or lower-priced homes. Some of that spending this year reduces what will be spent next year, and the year after. Consumer spending is not likely to pull us out of the current economic quagmire very soon.

Consumers will practice personal economic fundamentals. Live within your means, save, delay consumption, minimize debt — even if it appears cheap. Focus on short-term and long-term survival. Protect your home, in all ways. It is not a piggybank. It is your family’s personal shelter. Take care of it, physically and financially

• Mortgage products are returning to fundamentals.

Rates will be low, but it is tougher to qualify. During the real estate boom years, mortgage-financing terms offered by some lenders were flawed in many ways, ultimately with disastrous consequences for the borrower. Currently, we will see mortgage terms that reflect common sense — down payments of 10 percent to 20 percent, with the ratio of total debt payments to income ratios under 40 percent. There will be fewer teaser adjustable rate loans. If you can’t easily understand the terms of a mortgage loan, don’t sign.

• The business, or commercial customer is seeing changes in bank financing too.

Bankers are re-emphasizing the importance of cash-flow, rather than collateral. Cash flow can be spent. Collateral can disappear in a heartbeat. The old standard known as the 5 Cs of credit is back in charge. The borrower should have: character, the willingness to repay; capacity, the income or cash-flow; capital, a savings cushion; collateral, backup security; and conditions, a healthy economic environment.

Business loan pricing based on prime rate should be stable for the next year, as the Fed focuses on stimulating the economy, and thus managing low interest rates. A business that generates cash, and doesn’t rely upon the real estate markets, is a prime target for all business banks.

• Interest rates outlook

With the prime rate currently 3.25 percent and the fed funds target rate range currently 0 percent to 0.25 percent, most economists expect to see little change in short-term rates by the Fed in 2010. The market may move long-term interest rates, though, as risk levels and business conditions change during the year.

Also, mortgage rates are being held down due to the Fed’s Mortgage Backed Security Purchase Program, set to expire in February. Mortgage rates would likely rise in response, if the program is not extended.

Interest rates for 30-year mortgages are generally priced off 10-year Treasury bond rates. Estimated mortgage rates for 2010 are: 4.75 percent to 5.5 or 6 percent for a 30-year fixed loan; 4.25 percent to 5 or 5.5 percent for a 15-year fixed loan and 4.25 percent to 4.70 or 5 percent for a one-year ARM.

Last year was pretty much a horrible year for the local and national economy. We want to be optimistic, but our financial troubles will likely last through 2010. Take heart, though, as America is loaded with safety nets. A return to the basics, and a resolution to thrift, value, and necessity, should hold you in good stead for 2010 and beyond. Remember, you are not alone, and the government has a very large security blanket.