I have heard that whenever a bank takes on a property that they have to hold $7 in reserve for every $1 that the property is worth. Also, along with that whenever a bank gives out a loan, it only needs 10% of that money in the bank at that moment.
So for example.
100k REO = 700k in reserve
while this leads to being unable to make loans on 7million.
Is this True!?!?
I don’t know about the first question but I believe the answer to the second is yes. Although regulators can change the reserve percentages for loans. This along with adjusting interest rates and the buying and selling of bonds are the three main ways the supply of money is regulated.
Well if that 7:1 ratio is true, then it is obvious that banks are more than willing to do short sale. They aren’t looking at that house being 100k they are looking at that being 700k in reserves and 7MILLION unable to be loaned out…
Okay lets set the record straight. The banking industry has a number of different reserve requirements. First, all banks have a minimum capital requirement of between 4% and 8% of risk-adjusted assets. They must have this on the books to keep their doors open. Think of it in these terms; if you sold all the bank’s assets and paid off their depositors this capital reserve is what is left over. Second, all banks have a reserve requirement mandated by the Federal Reserve which runs at about 10% of net transaction accounts. This is basically cash stashed with the Fed to provide liquidity to the banking system. Finally there are general and specific reserves that bank management will set aside to protect from future losses on troubled assets such as defaulted loans and REO. When a bank takes back a foreclosed property they must by regulation write down the value of that property to its fair market value. Banks are NOT required to set aside $7 for every $1 in REO. That makes little sense as the most a bank can lose on a $1 asset is $1. I suspect this information is coming from sources not familiar with banking regulations or construing information to suit their needs. My 2 cents as a former bank regulator.
It’s called Loan Loss Reserve (LLR) and lenders are required to hold 3-5 times the mortgage amount in default. It’s not for REO it’s required through the pre-foreclosure process and the LLR is released when they short sale, sell the note or get it back as REO.
WAMU has close to 2 billion in LLR maintaing their defaults! They wen’t from 1 billion to close to 2 biliion in just the 4th quarter.
Hope this helps
Lenders are NOT required to hold 3-5 times the mortgage amount in default as loan loss reserves. Loan loss reserves are set aside to protect the ENTIRE loan portfolio from future defaults. Yes, WAMU has $2 billion in reserves but they have like a $250 billion loan portfolio which equates to approximately 0.8% in loss reserves. Perhaps if you compared the total LLR to only those loans in default you might reach a number close to the stated 3-5 multiple but that analysis would be in error. Again, LLRs protect the entire loan portfolio not just loans in default.
Here are the facts; Wamu below as an example,
Data as of 12/31/07:
Loans held in portfolio: $244 billion
Loan Loss Reserve: $2.6 billion
Loan Loss Reserve Ratio: 1.05%
Total Non-accrual* loans in portfolio: $6.1 billion
Loan Loss Reserve: $2.6 billion
Loan Loss Reserves as % of non-accrual loans: 42.15%
*Non-accrual loans = loans over 90 days past due and no longer accruing interest.
If banks were required to hold 3-5 times the mortgage balance in default as reserves then WAMU would have reserves of at least $18 billion. If you have details to contradict this please post them for the benefit of the forum.
I like your explanations on bank reserves. The fed has info scattered across their various websites as well. Can you direct people to a website that says what you have said in your posts. Maybe this will help people get a better grip on the reserve issue.
This may appear to be me asking you to prove yourself but in reality it is directing the mbrs to a site(s) with the reserve info clearly explained. It’ll help all of us.
As you’ve discovered with the Fed’s website there is information available but given that there are five different bank regulatory agencies (Fed, FDIC, OCC, OTS, NCUA) it can be difficult to find summary information in one location.
Keeping the discussion strictly to Loan Loss Reserves (LLR’s). There is no magic regulation or law that tells a bank it must have X% LLR’s but there is an abundance of guidance from the regulators telling banks that they must maintain ‘adequate’ LLR’s at all times. The adequacy is judged by bank examiners and independent auditors.
In practice bank management reviews their overall loan portfolio, economic trends and historical loss experience to come up with reserve percentages. These percentages are then applied to the loan portfolio and that is how LLR’s are determined. As economic conditions warrant management will (should) change these percentages to accommodate the new reality. Recall WAMU’s LLR’s increased from $1 billion to $2.6 billion in short order. Don’t forget that LLR’s come in two flavors; general which protect the entire loan portfolio and specific which are assigned to specific troubled loans that management has identified as potential loss.
The FDIC publishes a quarterly banking profile which highlights trends within the industry including non performing loans and LLR’s. The website also features a tool for pulling the financial data on any bank in the country which can be helpful when you are shopping for a lender or negotiating a short sale.
Quarterly Profile: http://www2.fdic.gov/qbp/index.asp
Institution Directory: http://www2.fdic.gov/idasp/main.asp
The OTS, regulator for savings & loans, publishes their examiner guidelines and regulations on-line. The link below is their guidance for judging the adequacy of valuation allowances (LLR’s).