Thursday, January 15, 2009

More & More Foreclosures

Home foreclosure filings for 2008 totaled 3.16 million. To put that in perspective, existing home sales are running at about a 4.4 million annual pace. The market is creeping up on a year's worth of sales in terms of possible foreclosures.

Also worth noting is the increase in foreclosures among prime (high credit ratings) borrowers. At a rate of 1.6% (foreclosures as a percentage of loans), the market has witnessed a 3 fold increase.

How does this cripple banks? Foreclosures and loan losses are obviously linked. Banks are typically leveraged $10 to $1, their assets are 10 times larger than their capital base. Assets are equal to the sum of liabilities and capital. When a loan (asset to the bank) is written off, assets are depleted and a corresponding adjustment needs to be made to either liabilities or capital. Just because a bank has trouble with its assets doesn't mean it gets a break on money it owes, so liabilities won't drop. Capital is decreased by the same amount as the loan write off. So, a bank (on average) can only survive a 10% failure rate on its assets until it sinks.

No comments: