Lenders Dumping Bad Loans at Discount; Regulators See Losses Continuing

Federal regulators warned Thursday that banking-industry turmoil would continue as financial institutions come to terms with piles of bad loans they made to finance the construction of homes and condominiums.

We've seen a real change in the market," says Ricardo Chance, a managing director at KPMG Corporate Finance LLC, who is helping troubled builders restructure their businesses. "Finally the banks are capitulating and saying, 'Let's mark to market and flush this all out.' The market is going to get worse. We don't want to hold on to this stuff

Until now, most of the damage to banks from the housing crisis has come from homeowners defaulting on their mortgages. But amid a dismal spring sales season for new homes, loans to home and condo builders are looking increasingly shaky. Banks have begun to dump them at what will likely be steep discounts, setting the stage for billions of dollars in fresh losses.

"As long as the housing market is on a downward path, as long as those prices continue to fall, I think there's a risk that the losses could continue to mount on a variety of loans," Federal Reserve Vice Chairman Donald Kohn told the Senate Banking Committee Thursday.

At the same hearing, Federal Deposit Insurance Corp. Chairman Sheila Bair said banks that aren't diversified, or those with high exposures to residential construction and development, are of particular concern. "That's where we are really seeing the delinquencies spike," she said.

The surprisingly gloomy outlook is at odds with the sentiment of investors, who appear to have moved on from worrying about the health of the financial system to obsessing about gasoline prices and consumer spending. The Dow Jones Industrial Average rose 213.97 points, or 1.7%, on Thursday on the back of surprisingly strong retail-sales data.