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Banks, financial system adjusted to postcrisis realities

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The financial system made significant progress in general in 2011 but has yet to recover completely. As the year ended, the housing sector was still weak and posed a significant hindrance to the health of the financial system. For the year as a whole, sales of new homes were at their lowest level since the federal government began keeping records in 1963. Homes in foreclosure continued to clog the market and exert downward pressure on house prices.

Policymakers have developed several programs to try to restore the health of the housing market since the mortgage crisis began. So far, these housing relief programs have had limited success. For example, in 2009, the Federal Housing Finance Agency (FHFA) introduced the Home Affordable Refinance Program (HARP). This program was intended to allow qualified borrowers with mortgages owned or backed by one of the government-sponsored enterprises to refinance, even if these borrowers would not qualify for a traditional refinance. The FHFA hoped that HARP would reach 5 million homeowners. However, by the end of 2011, only about 1 million mortgages had been refinanced through HARP. Housing experts suggest the relatively low participation rate can be partly attributed to lender worries about GSE putback risks. The Home Affordable Modification Program (HAMP) is a federal program created to help financially struggling borrowers lower their monthly payments rather than refinance their mortgages. HAMP also has had only moderate success. Policymakers continue to debate and discuss relief programs that could bolster the housing market and spur economic growth.

Some bright spots appeared last year despite the generally depressed state of the housing market. At the end of December, the national inventory of homes for sale stood at just over a six-month supply, down from a high of 11 months in the third quarter of 2010, according to the National Association of Realtors. Such a decline must occur before the housing market can improve. A supply of about six months is generally considered the market's equilibrium. See the chart.

Sidebar: The Southeast housing market reflected lasting effects of boom-bust

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The continued drag of housing on the economic recovery in 2011 was a national story. But the critical role of housing may have been even more pronounced in the Southeast—and especially so in the region's once-booming housing markets, including metropolitan Atlanta.

Fueled by dynamic in-migration, home construction in turn powered strong economic growth in Atlanta before the recession. From 2000 to 2006, no metro area in the country issued more residential building permits than Atlanta. During those years, builders took out more than 68,000 residential permits on average each year, compared to fewer than 9,000 in 2011. See the chart. Furthermore, Atlanta saw the nation's biggest decline in single-family home prices between November 2010 and November 2011, according to the S&P/Case-Shiller Index.

Atlanta's long-standing reliance on population growth and the housing industry served to restrain the area's economic recovery. At the end of 2011, metro Atlanta's unemployment rate was 9.3 percent, compared to 8.5 percent nationally.

Other once-booming housing markets in the Southeast, including Miami and Tampa, also suffered unemployment rates higher than the national average as 2011 ended. The year-end jobless rate in the Miami-Fort Lauderdale-Pompano Beach metropolitan area was 9.5 percent, and in Tampa-St. Petersburg-Clearwater, it was 10.1 percent.

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Banks' efforts to repair their balance sheets took place in a challenging environment. Consolidation in the industry continued throughout 2011. At year's end, the Federal Deposit Insurance Corporation (FDIC) was insuring some 7,400 institutions—about 300 fewer than it had insured a year earlier. Some banks failed outright. Others merged—the FDIC listed almost 200 bank mergers during the year, about a 15 percent increase from the number that occurred in 2010.

Banks were also adapting to the first full year of regulatory reform after Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Key elements of this large and complex legislation were intended to enhance financial stability; reduce taxpayer exposure to losses from failing financial institutions, including preventing "too big to fail" occurrences; strengthen consumer protection; and strengthen investor protection.

The Federal Reserve and other federal financial regulators were in the early stages of formulating and implementing regulations under the act. Striking the right regulatory balance was and continues to be critical, said Michael Johnson, senior vice president and head of the Atlanta Fed's Supervision and Regulation Division. See the video. The Fed, along with the other regulatory agencies, worked to ensure as much as possible the safety and soundness of the financial system without crippling the ability of financial institutions to make a profit.

As Federal Reserve Governor Daniel Tarullo explained in testimony before the Senate in December 2011, such efforts mean "implementing the [Dodd-Frank] statute faithfully, in a manner that maximizes financial stability and other social benefits at the least cost to credit availability and economic growth." To that end, Federal Reserve teams of supervisors, legal staff, economists, and other specialists worked to develop practical rules and to avoid unintended consequences of regulation. In particular, the Federal Reserve tried to minimize the regulatory burden on smaller financial institutions.

"It's a multiyear process," Johnson said of implementing a new regulatory regime. "It's still very much in the early stages."

Finally, smaller banks especially were trying to adjust their business models by reducing their reliance on lending secured by real estate. As small banks worked to diversify away from real estate lending, they faced a new challenge, as the demand for loans from businesses and consumers was not strong in 2011.

Sidebar: Southeast banks worked to lower real estate concentrations

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During 2011, total assets at Southeast banks declined by 8 percent from the prior year, more than double the decline at banks outside the region. Meanwhile, southeastern banks were working to change the composition of their loan portfolios. Most notably, they sought to reduce exposure to real estate. Banks had some success with regard to commercial real estate (CRE). Between 2001 and 2007, CRE loans had risen from about 33 percent to 55 percent as a share of total loans at Southeast banks with less than $10 billion in assets. By the end of 2011, CRE concentration for these smaller southeastern banks had declined to 49 percent of total loans.

But reducing concentrations in residential real estate proved to be a protracted process. Banks faced the reality that the backlog of homes for sale had to shrink before banking conditions could substantially improve. In addition, soft new loan volume made it hard to counterbalance existing real estate assets. Without strong demand, banks found it difficult to increase lending—particularly community banks that traditionally relied heavily on real estate lending.

On a brighter note, the latter half of 2011 saw southeastern banks' capital positions, nonperforming loans, and even earnings improve. Asset quality in the region was significantly better. Charge-offs fell late in 2011 to their lowest level since the worst of the financial crisis in 2008. See the chart. These improvements allowed banks to reduce their provisions to cover loan losses, which in turn helped boost profits. Still, in all these areas, banks in the Southeast improved less than their peers did nationally.

The residential mortgage market in the Southeast also somewhat improved on a year-over-year basis in every major mortgage delinquency and foreclosure category. For example, total past due first mortgages fell from 17.2 percent in December 2010 to 16.3 percent in December 2011. Seriously delinquent loans dropped slightly, as did foreclosures. See the chart.

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In the fourth quarter of the year, annualized loan growth for all commercial banks was 7.8 percent. However, the loan volume of smaller banks had shrunk by about 1.7 percent while larger banks had experienced annualized growth of 10.4 percent, according to data compiled from bank call reports filed with regulatory agencies.

Meanwhile, issuance of consumer asset-backed securities (ABS) was relatively unchanged from 2010 See the chart. New auto ABS continued to experience issuance close to precrisis levels, increasing from about $58 billion in 2010 to about $68 billion in 2011. Credit card and student loan securitizations remained subdued. The slow pace of credit card ABS issuance is consistent with the broader trend of consumers paring down their debts. (See the section on household deleveraging.)

The financial system generally—and the banking sector particularly—made progress on balance sheet repair during 2011, but did not return to full strength.