Jobs and real estate have long been intertwined in the economic cocktail. Standard and Poor's recently examined the impact of a potential double-dip in housing on the banking sector. I asked Devi Aurora, senior director for financial institutions ratings, about the study and what banking investors need to know.
LL: The latest housing price numbers pretty much erased any "recovery" scenario for the industry. What kind of impact will this have the on the banks which already have a load of foreclosures on their balance sheets?
DA: Based on the pessimistic scenario we outlined in our report, we estimated that credit losses could increase by an additional $30 to 35 billion in a potential downside scenario.
LL: Will we see more bank failures than forecasted because of this extended weakness?
DA: We did not include bank failures as a dimension of this exercise.
We did however look at profitability impact for the banking sector as a whole however, and estimated that if total losses of about 70-80 billion were recognized, this would equal approximately 30-35% of projected pretax operating income for the banking sector.
LL: What is the probability of a double dip in housing between now and the end of this year?
DA: Our in-house economics team associates 20 percent odds with the more pessimistic scenario as detailed in our report. In our baseline scenario, we assume a further 5% decline in house prices, whereas in the pessimistic scenario, we would see prices dropping by another 15%.
LL: Why do you think this point a double-dip scenario seems unlikely?
DA: Our definition of double-dip was premised on a 15% further decline in home prices (and increase in mortgage rate to 6.5%, among other things), and at this point, we are not yet seeing declines of that magnitude, though we will continue to monitor the situation.
LL: If there was a double dip, what kind of losses would the banks be looking at if that happened?
DA: Based on the pessimistic scenario we laid out, we saw about $30-35 billion in credit losses, another $30-35 billion in rising putback claim/warranty costs, and $6-12 billion lost as a result of fewer originations. That adds up to roughly $70-80 billion in total, although we note that these losses would likely be spread over several quarters.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."