Minnesota's banks are bruised, but healing

After being hammered by loan defaults for more than a year, Minnesota banks finally appear to be recovering from the worst economic downturn since the Great Depression.

On Tuesday, the Federal Deposit Insurance Corp. reported that Minnesota's banks earned $64.8 million in the third quarter, up 64 percent from the previous quarter but still down significantly from the first quarter and from a year ago. And while loan losses and delinquencies remain much higher than they were a year ago, they have begun to abate -- a hopeful sign, say analysts, that the apparent end of the recession may help stabilize bank balance sheets.

Even so, no one is predicting a sudden turnaround in credit quality, or an end to the ongoing parade of bank failures each Friday. Nationally, the number of banks on the FDIC's "problem list" at greater risk of failure rose to 552 from 416 on June 30, the highest level in 16 years. Fifty banks failed during the third quarter -- the largest number since the second quarter of 1990. Nationally, banks are charging off loans at the fastest pace since institutions began reporting quarterly income in 1984, according to the FDIC.

"Today's report shows that while bank and thrift earnings have improved, the effects of the recession continue to be reflected in their financial performance," FDIC Chairman Sheila Bair said at a Washington news conference.

Nationwide, banks made $2.8 billion in the third quarter, but more than one-quarter of banks (27 percent) are losing money. The numbers look slightly better in Minnesota, with 23 percent of Minnesota's 422 banks losing money.

As a whole, state banks are benefiting from decisions they made earlier in the year to curb their exposure to real estate developers and builders. Many of those loans already have been charged off for losses, and replaced with new loans that are profitable, say analysts and bank executives.

"One quarter does not a trend make," said Larry Albert, president of Central Bank of Stillwater, which has acquired four failed banks, including one last week in Florida, since late August. "But the banks are going to lag the economy, and if they're calling a turn of the economy three or six months ago, then you would expect banks to start getting somewhat better."

Another encouraging sign: Minnesota's banks have dramatically reduced their exposure to construction and development loans, a category of lending that has been particularly hard-hit by the collapse in housing prices. Total construction and development loans have fallen to $4.17 billion from $5.19 billion a year ago, according to the FDIC.

Still, Minnesota banks are not setting aside as much money to cover future losses as they did a year ago -- and not as much as the rest of the U.S. banking sector. This leaves banks with less of a cushion if economic conditions deteriorate again, or if there is a another steep drop in real estate prices, say analysts.

Over the past year, the ratio of past-due and nonaccrual loans -- or loans for which payment is in doubt -- as a percentage of total loans has jumped to 3.14 percent from 2.2 percent. Over the same time, however, Minnesota banks' reserves as a percentage of loans has fallen from 61 percent to 53 percent, which means that for every $1 in troubled loans the banks have set aside just 53 cents. Nationwide, the ratio stands at 60 percent.

That's worrisome at a time when many of Minnesota's banks are still heavily concentrated in commercial real estate, say experts. These loans for shopping centers, office buildings and strip malls are widely seen as the biggest threat facing the banking industry.

"We've experienced the first significant wave [of loan losses], but there are still some ripples in the pond," said Jeff Judy, owner of a bank consulting firm in Bloomington. "We've gotten through most of the residential real estate stuff. But there are some other rocks that will be thrown in the pond behind it."

And despite signs of improvement, a handful of Minnesota banks have seen their capital levels drop dramatically as a result of loan losses. Eight banks across the state are not considered adequately capitalized by federal regulators. So far this year, six Minnesota banks have been seized by regulators, while 124 have failed nationally.

"We still have some walking dead," Judy said. "There are probably three or four banks out there [in Minnesota] that probably should have been closed already."